Financials: Digital banking | Where's your money?

Financials – Digital Banking | Where's your money?

Financials

Digital banking | Where's your money?

Are Indian banks ready for the upcoming ‘Uberization’

The ‘Uber’ moment in Indian banking is here

Challenger “banks” can now

compete with incumbents

without capital or physical

presence. The ‘Uber’

moment for Indian banks is

upon us. Are the

incumbents ready?

The Indian banking sector is witnessing dramatic technological change and

disruptive innovation (beyond the immediate, obvious asset quality challenge). With

the RBI issuing “differentiated” licenses, the competitive landscape for incumbent

banks is changing like never before. The two biggest classic competitive advantages

(for incumbent banks) that acted as entry barriers (for challengers) are redundant.

Just as Uber (with zero-ownership of cabs) emerged as a global leader in ‘cab

sharing’, it is now possible for challenger “banks” to compete with incumbents

without capital (P2P lending) or without physical presence (payment technologies).

The ‘Uber’ moment for Indian banks is upon us. Are the incumbents ready?

Forces at play to reduce

cash intensity in the Indian

economy from 70% to 40%

of consumer payments

Cash intensity of the Indian economy likely to reduce

While the Indian economy continues to be dominated by cash (12% of India’s GDP

and 70% of consumer payments by value), a combination of policy and consumer

behavior is seeking to reduce the economy’s dependence on cash. Given the RBI’s

stated intention of reducing the share of cash transactions in the economy (policy

push factor) and the consumer’s need for convenience (customer pull factor), the

cash intensity of the Indian economy is expected to reduce to 40% of consumer

payments (in value terms) by 2019.

“Digitally-enabled”

consumers looking to

complete the “awareness-

to-purchase” loop on digital

platforms - hence, the

mushrooming of multiple

payment systems

Rise of the “digitally-enabled” consumer; growing need for digital solutions

An increasing proportion of the consumer’s decision-making process (beginning with

awareness followed by research, comparison, choice and ending with the eventual

purchase) is beginning to migrate to the digital world. With smartphone penetration

in India at ~17% (and rising at an exponential 45% CAGR), the “digitally-enabled”

Indian consumer is increasingly looking to fulfill the decision-making loop on the

digital platform itself. Consequently, the payments ecosystem in India has witnessed

frenzied activity over the past year, with 2-3 “digital banking apps / mobile wallets”

being launched every other month.

Financials

Digital banking | Where's

your money?

Customer acquisition -> transactions -> analytics -> cross-sell

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While challengers (payment banks and contenders) have been focused on acquiring

customers (through cashback offers, freebies), incumbent banks have been focused

on enabling and facilitating transactions. However, analytics-based cross-selling of

financial products remains the Holy Grail for all service providers. We believe that

technology-enabled cross-sell is the only way for banks to clock non-linear growth in

customer profitability (when revenue per customer will see a disproportionate rise

compared to the cost per customer).

9 March 2016

Financials – Digital Banking | Where's your money?

Transactions and SMEs will

be the new battleground

“Transaction” market share will determine “deposit” market share

Our analysis suggests a strong positive correlation between (a) the number of non-

bank transactions from a savings account, and (b) the average balances maintained

in such accounts. As this behavior entrenches itself further, we expect incumbent

banks and challengers to increasingly engage, target and segment consumers on the

new battleground – transactions. We also expect “mid-sized businesses” to be a

hotly-contested segment, as banks look to build a protective “network effect”.

Compounding effect on the

P&L; non-linearity on the

income front has greater

implications for RoAs

P&L impact: “Dual Advantage” or “Double Whammy”

While all banks are launching their own digital platforms, we argue that non-linear

benefits will only accrue to banks that are able to build superior cross-sell

capabilities to monetize their customers better. We expect the top-quartile banks to

generate an RoA alpha of ~100bp (from the current levels of 80bp) over the sector

average at an operating profit level over the next five years. Nearly all of this RoA

alpha will be driven by cross-sell fee income and higher customer profitability.

KMB, HDFCB and SBIN are

the best plays based on our

MODQ methodology

KMB, HDFCB, SBIN emerge with early leads on proprietary Digital Quotient

We build an industry-first, proprietary Motilal Oswal Digital Quotient (MODQ) score

to identify early movers across three key categories: scale, transaction activity and

product capabilities. In our analysis of the 10 largest banks in the system, we find

Kotak Mahindra Bank (KMB), HDFC Bank (HDFCB) among the private banks and

State Bank of India (SBIN) among PSBs as best positioned plays on digital banking.

The private sector banks have been far more successful in encouraging transaction

activity levels and float (crucial for revenue generating opportunities). In general, we

believe that the eventual winners in digital banking will be entities that master the

“small value, high volume” transactions war.

AXSB appears most levered

to the G2C opportunity;

ICICIBC offers choice but

needs to monetize its digital

offerings better; YES has

built a very strong merchant

presence (benefits for CA

once activity levels pick up)

and appears to be in an

investment phase

Quasi-corporate lenders (AXSB, ICICIBC and YES) carefully positioned

We believe it is also worth highlighting the evolution of the quasi-corporate private

sector lenders. Axis Bank (AXSB) has been prolific in adding merchants but there is a

lot more groundwork that needs to be done in terms of raising activity levels and

digital maturity levels of its individual customers. ICICI Bank offers a host of digital

choices to customers that are high on recall and customer convenience - the bank

now needs to find a way to monetize these digital offerings. Yes Bank, despite being

a late convert to the utility of a retail franchise, has been commendable in its pace

of merchant acquisition and its use of business correspondents - however, the bank

appears to be in an investment phase since activity levels are sporadic at best.

Game-changers and catalysts

Government could offer

incentives to customers as

well as vendors to fast-track

the pace of digitization.

Digitization of government

payments and P2P lending

could emerge as potential

game-changers.

From a near-term perspective, we believe that the Cabinet approval for promotion

of payments through digital means could accelerate the pace of digitization. We

believe that digitization of government payments (G2B and G2C) is a near-term

catalyst, which alongside the launch of the Bharat Bill Payment System (BBPS) can

also potentially disrupt the flow of working capital funds from banks to corporate

India. P2P (peer-to-peer) lending could also emerge as a potential game-changer for

banks on both sides of the balance sheet.

9 March 2016

Financials – Digital Banking | Where's your money?

Motilal Oswal Digital Quotient (MODQ) - Summary

4 Pillars, 14 Metrics - Triangulating the 3 early leaders

Benchmarking exercises are incomplete without a sensible, logically-defined framework

that helps separate the wheat from the chaff. As we set out to benchmark incumbent

banks on their digital banking readiness, we construct an industry-first, proprietary Motilal

Oswal Digital Quotient (MODQ) built around four fundamental pillars: 1) Scale; 2) Activity

levels; 3) Digital maturity; and 4) Product capabilities and evaluate top banks on fourteen

different metrics. We identify Kotak Mahindra Bank (KMB) and HDFC Bank (HDFCB) among

private banks and State Bank of India (SBIN) amongst the PSBs as early leaders on our

MODQ framework. Given the recent vintage of some of these metrics as also moving parts

around digital behavior and disclosures, we believe MODQ will gradually evolve - both in

terms of its constituent metrics as well as the lead indicators. As with any other piece of

statistic, it shall be our endeavor to tighten the current MODQ framework as the sample

size increases over the next few quarters.

We build the MODQ around four distinct categories, which together encompass the

parameters that we believe are necessary for a successful digital banking franchise -

scale (number of customers), activity levels (savers v/s spenders), range of banking

products / services (cross-sell) and the digital maturity of customers (“channels”).

Exhibit 1: Motilal Oswal Digital Quotient (MODQ) - Framework Summary

SCALE

ACTIVITY LEVELS

MODQ

PRODUCT CAPABILITIES

DIGITAL MATURITY

Source: RBI, MOSL

Another way to understand this framework is to think of the following cycle:



How large is the bank’s customer base and at what pace is the bank on-boarding

its customers? [Client acquisition to build scale];



How active are these customers in terms of transaction frequency and

transaction ticket size? [Transaction frequency, Savers vs. Spenders];



How smartly do these customers transact? [What proportion of the customer

transactions is happening on digital channels]; and



Can the bank monetize these customers with other products? [Has the bank

figured out a way to intelligently cross-sell its most profitable products to its

high-potential customers?]

Our proprietary framework uses a set of 14 metrics across these four categories on

a subset of 10 banks - we have identified this subset on the basis of parameters such

as the systemic relevance and institutional ownership in these banks.

9 March 2016

Financials – Digital Banking | Where's your money?

Exhibit 2: MODQ Framework - Summary snapshot

MODQ scorecard

AXSB

BOB

HDFCB

ICICIBC

IIB

KMB

PNB

SBIN

YES

Source: MOSL

Scale

Activity

levels

Digital

maturity

Product

capabilities

Scale (4 metrics): In this category, we assess not only the size of the customer base

but also the pace at which each bank is adding to its customer base. To make this

ROI-driven, we normalize each metric within this category using a logical

denominator. Needless to say, PSBs feature heavily in this category.

Activity levels (5 metrics): We use a combination of metrics that reflect “customers’

propensity to save” and “customers’ propensity to spend”. While PSBs are heavy on

savers, private sector banks have a heavier mix of spenders.

Digital maturity (4 metrics): Having established a set of metrics for evaluating scale

and activity levels, we now assess the digital friendliness of a bank’s customers. The

more digitally mature a bank’s customers, the easier it is for a bank to push channel

migration, which offers significant tangible benefits in terms of cost optimization.

Two private sector banks (Kotak Mahindra Bank and HDFC Bank) emerge as outliers

in this category.

Product capabilities (1 metric): Finally, we look at the cross-sell potential to evaluate

banks’ ability to monetize customers by offering relatively more-profitable products

and services to their high-potential customers. This category is dominated by the

private sector banks led by HDFC Bank.

9 March 2016

Financials – Digital Banking | Where's your money?

Story in charts - Demographics & Consumer Behavior

Exhibit 3: Banking penetration v/s Internet penetration v/s Mobile penetration

Internet penetration is

growing the fastest;

mobile

penetration is beginning to

plateau while banking

penetration has got fresh

legs after the launch of the

PMJDY scheme

Mobile

Internet

53%

30%

80%

Banking penetration

Internet

Penetration

402m

Mobile

Penetration

1,019m

MRR: 3m

MRR: 10m

MRR: 6m

MRR refers to “Monthly Run Rate of Accretion”

Source: PMJDY, RBI, TRAI, IAMAI, MOSL

Exhibit 4: Smartphone users to equal number of active bank accounts by 2020

Number of smartphones

expected to equal the

number of active bank

accounts by 2020

162

388 343

FY14

Number of non smart phone users

Number of active bank accounts

Number of smart phone users

224

389 387

FY15

304

364 434

FY16

386

477

467

525

291

FY18

550

577

243

FY19

625

629

195

FY20

332

FY17

Source: BCG Research, MOSL

Exhibit 5: Over 60% of online shopping in India happens on a smartphone

Over 60% of online

shopping

in India

happens

on a smartphone

Mobile website,

19%

Mobile app, 42%

Offline

Online

Desktop, 39%

Source: Media reports, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Story in charts - The policy push

Exhibit 6: JAM trinity will drive transaction frequency over the next five years

The JAM trinity will

not

only create bank accounts

but also seed them with

regular funds (through

direct transfers) to

drive

transaction frequency

Jan Dhan Yojana

(209m accounts)

Aadhaar

(970m

enrolments)

Mobile

subscription

(1b

subscribers)

Source: PMJDY, UIDAI, TRAI, MOSL

Exhibit 7: Share of cash transactions within total customer transactions (volume, value)

Cash intensity

in the Indian

economy

is expected to

reduce from ~70% to about

40% by 2019

98%

Volume

68%

Value

Source: PwC 'Disrupting Cash', MOSL

Exhibit 8: Impetus to branchless banking through the Business Correspondent model

Branchless penetration in villages

Branches

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Branchless mode

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Ratio of outlets: branchless to branch

FY10

33,378

737

1,328

34,316

806

312

1.0

FY11

34,811

792

1,663

80,802

576

226

2.3

FY12

37,471

1,353

2,932

141,136

184

3.8

FY13

40,837

1,634

4,033

227,617

224

5.6

FY14

46,126

2,169

5,925

337,678

334

115

7.3

FY15

49,571

1,736

7,363

504,142

397

148

10.2

Source: RBI Annual Reports, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Story in charts - The regulatory push

Exhibit 9: Transaction mix by value - 2015

Payment Systems

Large-scale clearing

Paper clearing

Retail electronic

payments

RTGS

CCIL

operated

INR 752t

(45%)

CAGR:

14%

ECS

NEFT

Cards

Others

INR 754t

(45%)

CAGR:

14%

INR85t

(5%)

CAGR:

-(4%)

INR 3.8t

(0.2%)

INR 59.8t

(4%)

INR 25.4t

(1%)

INR 2.0t

(0.2%)

CAGR:

15%

CAGR:

71%

CAGR:

96%

Percentages adjacent to the value indicate corresponding share within the payments pie; CAGR refers to 5-year CAGR from 2010-15

Source: RBI, MOSL

Exhibit 10: Significant cost benefits from channel migration in transaction mix (HDFC Bank)

FY05

Branches,

27%

Branches,

12%

Phone

banking, 4%

ATM, 53%

Internet &

Mobile,

63%

C-I ratio: 44.6%

Source: Company Presentation, MOSL

FY15

ATM, 21%

Phone

banking,

Internet &

Mobile,

13%

C-I ratio: 54.3%

Exhibit 11: RoA comparison (FY15) - top quartile banks v/s sector average

Top quartile banks will

expand the

“ROA alpha”

vis-à-vis the sector average

from 80bp (FY15) to over

100bp over the next 5 years

ROA tree (% of total assets)

Net interest income

Non-interest income

Operating expenses

Employee expenses

Operating profits

3.37

1.72

2.22

0.92

2.87

Sector average

2.64

1.15

1.77

0.96

2.02

Note: Q1 refers to the top quartile banks; this exercise excludes foreign banks

Source: RBI, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Story in charts - The paradigm shift in banking

Exhibit 12: Transaction accounts will be more valuable than mere CASA obsession

Banks will migrate from an

“obsession for CASA” to

“focusing on transactions”.

There is absolutely no

benefit from dormant

savings account if a bank

cannot encourage high-

frequency “smart

transactions”

ZERO BALANCE

ACCOUNT

DORMANT

ACCOUNT

Net interest

income from

float

TRANSACTION

ACCOUNT

Net interest

income from

float

Fees from

transactions

Source: RBI, MOSL

Loss-making

proposition

Exhibit 13: From “cost-per-transaction” to “cost-per-customer”

#of employees /

100,000 customer

(Customer

acquisition)

Products per

customer (Minning of

extsting accounts)

Channel migration

(Minimal Employee

Assistance)

Transaction frequency

(Build Network

Externalities)

Source: MOSL

Cost per customer

(INR)

Cost-to-income (C-I)

ratio (%)

Revenue per

customer (INR)

Exhibit 14: Acquire customers - Build transaction frequency - Encourage channel migration - Upsell and cross-sell

New

TECHNOLOGY-

BASED CROSS-

SELLING

Product/

Business

Models

SMARTER TECHNOLOGY-

BASED CUSTOMER

ACQUISITION AND DIGITAL

ON-BOARDING

CHANNEL

MIGRATION

Existing

Customer/

Market segment

New

Source: MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

The Uber moment for Indian Banking

“The battle is for the customer interface” - Tom Goodwin

The Indian banking sector is witnessing dramatic technological change and disruptive

innovation (beyond the immediate, obvious asset quality challenge). With the RBI issuing

“differentiated” licenses, the competitive landscape for incumbent banks is changing like

never before. The two big classic competitive advantages (capital and physical presence)

that acted as entry barriers for incumbent banks are no longer relevant. Just as Uber (with

zero-ownership of cabs) emerged as a global leader in ‘cab sharing’, it is now possible for

challenger “banks” to compete with incumbents without capital (P2P lending) and without

physical presence (payment technologies). The ‘Uber’ moment for Indian banks is upon us.

Are the incumbents ready?

A confluence of factors has

ensured that the two classic

competitive advantages for

incumbent banks - capital

and physical network - are

now rendered redundant.

While there is no doubt about the immediate near-term focus on Indian banks’ asset

quality challenges (both known and unknown), there is a larger force at play that

impacts the very existence and survival of Indian banks as we know them. The

sector is witnessing unprecedented technological change and disruptive innovation.

A confluence of factors has ensured that the two classic competitive advantages for

incumbent banks - capital and physical network - are now rendered redundant. With

the RBI issuing “differentiated” licenses to a wide assortment of entities, it is now

possible for challenger “banks” to compete with incumbents without capital (P2P

lending) and without physical presence (payment technologies).

Although most challengers are riding piggyback on traditional brick-and-mortar

banks, the competitive landscape for incumbents is changing like never before. As

customers use more and more of these disrupter services, their expectations of

their “primary” bank are rising rapidly. They want services, delivered at the swipe of

a smartphone screen, wherever and whenever they happen to be - “on the move”.

And as more of their financial services get delivered this way, it will be increasingly

easier for users to step away from the inertia of their traditional bank.

Own the interface - Own the customer - Own the wallet

We expect challengers to disproportionately focus on the interface layer, where all

the value and the profit resides. The primary objective will be to match the vast

supply (which is where the costs reside) to the huge demand ecosystem (which is

where the revenues will be). While the demand ecosystem is open to every licensed

entity, incumbent banks own the supply system (and hence, incur the costs). As with

any other disruption, the ones who own everything have everything to lose.

The digital challengers have spurred traditional banks to innovate. A number of

leading banks are building payments-linked ecosystems for their customers. As the

banking landscape goes digital, we present this first-in-a-series thematic to explore

the various challenges and opportunities that lie ahead for incumbents.

9 March 2016

Financials – Digital Banking | Where's your money?

India: The “unbanked, under-banked” opportunity

Low per capita banking penetration - key to the digital opportunity

With just over 50% of Indians having a bank account, India suffers from one of the lowest

penetration rates for banking products / services. This has driven the demand for relatively

more accessible and affordable “banking” solutions to address the vast unbanked (~50% of

the population) and under-banked population.

Exhibit 15: Penetration of consumer payment instruments across countries

Households with bank account

Cards per capita

# of ATMs / 1,000 population

# of POS terminals / 1,000 population

India

53%

0.4

0.1

0.9

USA

88%

2.5

1.3

South

China

Brazil Germany

97%

64%

56%

98%

54%

2.7

3.1

1.4

1.7

1.1

0.4

0.5

25.8

7.8

34.3

9.1

5.8

Source: McKinsey, Motilal Oswal Payments Report, MOSL

High costs deterring banks from servicing low income households

Although the pan-India average household banking services penetration is low in

itself (Exhibit 15), policymakers are especially concerned with the asymmetric access

to banking services for customers across different income buckets.

Exhibit 16: Banking penetration* within each income quintile (%)

Qntl 1

Qntl 2

Qntl 3

Qntl 4

Qntl 5

* Proportion of households with a bank account within each income quintile

Quintile 1 denotes the lowest income quintile while Quintile 5 denotes the highest income quintile

Source: NCAER, MOSL

The lack of greater penetration of financial services is ostensibly on account of the

high transaction costs (per customer) involved in sourcing and servicing the small-

ticket needs of the customers within the bottom quintile (largely in rural branches).

Exhibit 17: Average ticket-size of deposits and loans by branch type (INR)

Ticket size analysis by branch type

Rural

Semi-urban

Urban

Metropolis

All India

Deposits

19,358

33,510

74,033

173,901

64,854

Credit

109,531

173,439

507,735

1,247,713

452,760

Source: RBI, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

As highlighted in Exhibit 17, the average ticket size of deposits and loans mobilized

in rural and semi-urban branches is less than half the pan-India average. Also, the

set-up and operational cost that a bank incurs in servicing its customers through its

physical infrastructure (branches and ATMs) is especially high (Exhibit 18).

Exhibit 18: Cost of a customer transaction across channels

Channel transaction cost

Branch

ATM

Call center

Offline BC model

Online BC model

Internet

Mobile

Cost (INR/txn)

40-50

13-17

8-10

4-6

2-4

0.2-0.5

<0.2

Source: RBI, MOSL

Given the relatively lower ticket sizes and higher costs, banks have been reluctant to

invest in expanding physical infrastructure in the rural and semi-urban centers.

Exhibit 19: Rural v/s Urban - disparity in physical banking infrastructure penetration

Population (m)

Area (% of total)

Area (m sq km)

Bank branches

Branches (per '000 sq km)

Branches (per 100,000 population)

Bank ATMs

ATMs (per '000 sq km)

ATMs (per 100,000 population)

Rural

737

95%

3.13

36,503

11.7

4.95

23,334

7.5

3.17

Urban

377

0.16

65,874

411.7

17.47

136,721

854.5

36.27

Source: Census 2011, RBI, MOSL

Digital banking the way forward for profitable financial inclusion

So, why is it necessary for banks to service these customers in the bottom quintiles?

Beyond the policy-imposed financial inclusion obligation, we believe there exists a

significant addressable opportunity for banks to service these income segments

profitably. Purely in terms of the size of the opportunity, as shown in Exhibit 20, the

income group below the middle class (in the annual household income range of

INR90k to INR200k) is likely to emerge as the largest group of customers.

200m households in the

bottom-most income

quintiles; 80% of these

(120m) will keep switching

between household surplus

and household deficit every

month. A banking product

for either possibility is a

HUGE business opportunity.

Exhibit 20: The bottom-most income quintiles are huge and can be serviced profitably

Household income

INR ‘000 per annum

>1000

500-1000

200-500

90-200

<90

Indian households by income

Distribution (m)

221

290

114

2010

120

2020

(3%)

Source: BCG, NCAER, MOSL

CAGR (%)

16%

13%

Largest customer segment-

“The Next Billion” – will

demand affordable low cost

banking offering

Fastest growing segment-the

rich households-to demand

quality wealth management

services

9 March 2016

Financials – Digital Banking | Where's your money?

A 10% surplus from the

annual household income

can add 2% to the deposit

pool; a 20% deficit for each

household will add 5% to

the system credit.

These customers can be profitably served only with low-cost business models having

low breakeven ticket size of business. Assuming ~10% of their annual household

income is channelized towards financial savings, the banking system can add nearly

INR1.8t (2%) to the deposit pool. However, households in this income segment are

often dis-savers (spending more than they earn), and hence, more often in need of a

credit product. Assuming a 20% deficit for each household in this income segment,

the demand for credit translates to at least INR3.6t (5% of overall system credit).

Given the low levels of overall financial inclusion and the disparities among different

regions (Exhibit 19) as well as income buckets (Exhibit 16), the RBI has been nudging

banks towards greater financial inclusion by encouraging alternate channels that are

focused on making financial services available, accessible and affordable to people.

One such approach is through the use of technology, which already boasts of higher

penetration (than traditional banking) and promises a cost-effective way of bringing

a larger proportion of hitherto-unbanked and under-banked customers into the

‘banking’ net. For instance, the number of consumers that are onboarding the

Internet and mobile platforms is significantly higher, with India adding about 10m

Internet users and 6m mobile subscribers every month. The higher penetration of

the Internet and mobile formats holds the key to the digital banking opportunity.

Exhibit 21: Banking penetration v/s Internet penetration v/s Mobile penetration

Internet penetration is

growing the fastest;

mobile

penetration is beginning to

plateau while banking

penetration has got fresh

legs after the launch of the

PMJDY scheme

Mobile

Internet

53%

30%

80%

Banking penetration

Internet

Penetration

402m

Mobile

Penetration

1,019m

MRR: 3m

MRR: 10m

MRR: 6m

MRR refers to “Monthly Run Rate of Accretion”

Source: PMJDY, RBI, TRAI, IAMAI, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Cash intensity of Indian economy likely to reduce from 70% to 40% by 2019

India has traditionally been a cash-dominated economy, with cash transactions

accounting for over 98% of consumer payments by volume and 68% of consumer

payments by value. With the RBI’s stated intention of reducing the share of cash

transactions in the economy (policy push factor) and the consumer’s need for

convenience (customer pull factor), the cash intensity of the Indian economy is

expected to reduce to 40% of consumer payments (in value terms) by 2019.

Currently, ‘cash is king’ in Indian economy

The Indian economy is characterized by high cash intensity (cash in circulation at

over 12% of GDP is amongst the highest globally). With nearly 70% of consumer

payments (by value) being transacted in cash, it is no wonder that cash is king in the

Indian economy.

Exhibit 22: High cash-to-GDP ratio (%) in India points to a cash-intensive economy

12.4

9.5

7.9

7.5

4.2

4.0

3.9

3.4

India

China

Germany

Australia

Brazil

South Korea

Source: International Financial Statistics, IMF, RBI, MOSL

Yet another way to compare cross-country cash intensity is to consider the ratio of

monetary aggregates M

and M

. M

denotes the amount of money held in bills and

coins while M

denotes the amount of money held in demand deposit and savings

deposits.

Exhibit 23: Cross-country comparison of monetary aggregates (M0 as% of M2)

China

Mexico

South Africa

Egypt

India

51.0%

24.3%

5.2%

China

8.7%

8.9%

29.5%

Mexico

South Africa

Egypt

India

Source: Bank of International Settlements, MOSL

India has traditionally been a cash-dominated economy with cash transactions

accounting for 98% of the aggregate consumer payments (by volume) and 68% of

overall consumer payments (by value), lagging many of its emerging market

counterparts (Exhibit 24) in terms of electronic transactions.

9 March 2016

Financials – Digital Banking | Where's your money?

Exhibit 24: Share of cash transactions within total customer transactions (volume, value)

98%

Volume

68%

Value

Source: PwC 'Disrupting Cash', MOSL

Cash intensity declining, driven by regulatory push…

Given the humungous cost of cash (unaccountable money, shadow economy, tax

avoidance, etc), policymakers are seeking to reduce the economy’s dependence on

cash. The share of electronic transactions (30% by value of transactions during FY15)

is already reflecting a gradual reduction in cash intensity (Exhibit 25).

Exhibit 25: Indicative example of reducing cash intensity in metros ONLY

Channel migration in practice

Household expenses

House-help

Small-ticket groceries

Other domestic vendors

Travel

Leisure

F&B

Fuel

Rent

Groceries

Healthcare

Hospitalization

Consultation

Education

Clothing

Year 2005

Cash

Cash / card

Cash

Year 2015

Cash

Migrated

Card

Migrated

Cash

Migrated

Note: In case of multiple possible modes of payment, we attribute the most dominant payment mode

to the expenditure category

Source: MOSL

…and consumer’s need for convenience

While electronic payments are sneaking into customers’ purchase behavior (in the

case of e-commerce transactions), there exist variants such as cash on delivery

(COD) that reinforce the use of cash. In order to achieve real disruption of cash in

the economy, the ecosystem requires perfectly seamless substitutability between

cash and electronic payments.

With the RBI’s stated intention of reducing the share of cash transactions in the

economy (policy push factor) and the consumer’s need for convenience (customer

pull factor), the cash intensity of the Indian economy is expected to reduce to 40%

of consumer payments (in value terms) by 2019. We present a cursory collage of

FY15 Annual Report cover pages in Annexure-I to highlight the increasing focus on

digital transactions and interfaces.

9 March 2016

Financials – Digital Banking | Where's your money?

Emergence of alternate channels - The regulatory push

In their endeavor to enhance banking outreach (availability) and financial inclusion

(access) while simultaneously reducing the cash intensity in the Indian economy,

policymakers have been encouraging banks to explore and adopt various alternate

channels (branchless banking) through multiple initiatives.

Exhibit 26: Impetus to branchless banking since FY10 - BSBDA accounts

Branchless penetration in villages

Branches

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Branchless mode

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Ratio of outlets: branchless to branch

FY10

33,378

737

1,328

34,316

806

312

1.0

FY11

34,811

792

1,663

80,802

576

226

2.3

FY12

37,471

1,353

2,932

141,136

184

3.8

FY13

40,837

1,634

4,033

227,617

224

5.6

FY14

46,126

2,169

5,925

337,678

334

115

7.3

FY15

49,571

1,736

7,363

504,142

397

148

10.2

BSBDA refers to Basic Savings Bank Deposit Accounts

Source: RBI Annual Reports, MOSL

Higher number of accounts

≠ Higher banking activity

One such major initiative has been the government’s pet project ‘Jan Dhan Yojana’

(PMJDY), where sustained efforts have resulted in banks adding nearly 195m new

account holders during the past 18 months, raising banking penetration to ~50%.

However, the mere existence of a bank account is a statistic and hardly indicative of

true financial inclusion unless backed by active usage of the bank account. According

to the World Bank 2014 report, the dormancy rate in India is 43% against a global

average of 15% and an average of 5% in high-income OECD economies.

We argue that inactive accounts are a loss-making proposition for banks. There is a

need to regularly seed such accounts with funds and encourage frequent

transactions. While the government may populate non-salaried accounts at a

monthly or quarterly interval with a few direct benefits, the transaction frequency

can only rise when transactions become less cumbersome and more user-friendly.

Exhibit 27: Deriving the viability of an account

Nearly 43% of account

holders in India are inactive

(zero customer-induced

transactions over the past

12 months)

Banks will migrate from an

“obsession for CASA” to

“focusing on transactions”.

There is absolutely no

benefit from dormant

savings account if a bank

cannot encourage high-

frequency “smart

transactions”

ZERO BALANCE

ACCOUNT

DORMANT

ACCOUNT

TRANSACTION

ACCOUNT

Loss-making

proposition

Net interest

income from

float

Net interest

income from

float

Fees from

transactions

Source: RBI, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

While the objective of financial inclusion is theoretically achieved by a mere opening

of accounts, banks are increasingly using alternate, technology-enabled channels to

make such accounts truly viable. We believe that the value proposition by banks to

their customers will undergo a paradigm shift over the next 5 years.

Exhibit 28: Paradigm shift in banks' proposition to customers

VALUE PROPOSITION 2015

Deposits as a business;

payments are add-ons

VALUE PROPOSITION 2020

Payments as core service;

deposits are a derivative

Account-opening and

credit products become

available on-tap and on-

demand

Digital is core channel;

Branches are alternate

channels for specialized

functions

Bank co-owns the

ecosystem; influences the

consumer’s decision-

making process

throughout

Source: BCG, KPMG, PWC, MOSL

Account opening and

credit products are serious

paperwork activities

Digital is an alternate

channel; branches are core

to customer engagement

Decision-making happens

through other channels;

banks are merely for

payment function

9 March 2016

Financials – Digital Banking | Where's your money?

Battleground “transactions”: The war for “primacy”

Transaction market share will determine CASA market share

Digital technology has already resulted in a proliferation of transaction channels and a

massive surge in the number of transactions made by customers. Consequently, we expect

the industry to witness a structural shift in the competitive intensity for transactions as

incumbents as well as new entrants fight over the new battleground. We believe that

transaction convenience will determine transaction frequency and consequently, CASA

market share over the next five years. Banks that improve their share of transactions (by

offering greater convenience) will command a higher share of the low-cost CASA deposits.

As outlined in the earlier section, policymakers have been encouraging banks to

explore and adopt various alternate channels (electronic modes) through multiple

initiatives. Some of these initiatives are already beginning to bear results with the

share of retail electronic transactions inching up from sub-1% to over 5% during the

5-year period from FY10 to FY15. As can be seen from Exhibit 29, the 71% CAGR in

NEFT transactions demonstrates the decidedly-permanent shift from paper-based

transactions (cheques) to digital transactions.

Exhibit 29: Transaction mix by value - 2015

Payment Systems

Large-scale clearing

Paper clearing

Retail electronic

payments

RTGS

CCIL

operated

INR 752t

(45%)

CAGR:

14%

ECS

NEFT

Cards

Others

INR 754t

(45%)

CAGR:

14%

INR85t

(5%)

CAGR:

-(4%)

INR 3.8t

(0.2%)

INR 59.8t

(4%)

INR 25.4t

(1%)

INR 2.0t

(0.2%)

CAGR:

15%

CAGR:

71%

CAGR:

96%

Percentages adjacent to the value indicate corresponding share within the payments pie; CAGR refers to 5-year CAGR from 2010-15

Source: RBI, MOSL

It is worth highlighting that although ‘Cards’ have exhibited a 96% CAGR over the

same five-year period (2010-2015), a bulk of the card transactions (INR 22.3t; 88% of

card transaction value) are still in the form of ATM withdrawals. With POS (point of

sale) penetration still at 5-6%, we are convinced that the digital payments journey in

India has just begun. With the impending reduction in cash intensity within the

economy and the mushrooming of digital payment channels, we expect a tectonic

shift in the transaction mix towards pure digital transactions.

9 March 2016

Financials – Digital Banking | Where's your money?

“Transactions” market share to drive “deposits” market share

Banks that improve their

share of transactions will

command a higher share of

deposits

An analysis of the system-wide transaction data by the consulting firm BCG suggests

that higher the average savings balance per account in a bank, higher is the average

number of non-branch transactions per savings account in that bank. The customer

reasoning is obvious: “transactions” market share will determine “deposits” market

share. In the digital banking era, we expect a structural shift in the competitive

intensity for transactions, as incumbents and new entrants fight over the new

battleground.

While incumbent banks can afford to operate on a float-led model, challengers such

as payment banks (payment banks are not allowed to lend) have no choice but to

compete on a transaction-led model. As a result, we believe that transactions will be

the Holy Grail for incumbents as well as challengers over the next few years.

JAM trinity to facilitate higher transaction frequency

The JAM trinity is the most

powerful, game-changing

opportunity for the Indian

financial services sector

We believe that the confluence of three factors - Jan Dhan, Aadhaar and Mobile

penetration (also termed as the JAM trinity in recent policy documents) would help

facilitate higher transaction frequency. While the Jan Dhan campaign has helped

create / open accounts, Aadhaar is expected to help seed such accounts with direct

transfers (largely welfare-related transfers - see pages 32-34 for a detailed analysis

of how G2C payments are likely to play out over the next five years). The confluence

of JAM presents a game-changing opportunity for the financial services sector.

Exhibit 30: JAM trinity will drive transaction frequency over the next five years

Jan Dhan Yojana

(209m accounts)

Aadhaar

(970m

enrolments)

Mobile

subscription

(1b

subscribers)

Source: PMJDY, UIDAI, TRAI, MOSL

Open customer accounts -

seed customer accounts -

build network externalities

Once an account is created and is populated with funds, larger merchant / vendor

ecosystem (with appetite for cashless payments) and higher-quality mobile

penetration (or Internet penetration) are essential to drive higher transaction

frequency. While the government has taken the lead in Stages 1 and 2, we believe

that banks will need to build network externalities by tying up with multiple vendors

and merchants (including utilities) to make transactions actually profitable.

The Government of India (GOI) has also partnered with the United States Agency for

International Development (USAID) to launch initiatives specifically focused on

increasing the use of digital payments at point of sale terminals, particularly among

low-income consumers. Captured below are a few such emerging ecosystem tie-ups.

9 March 2016

Financials – Digital Banking | Where's your money?

The Ecosystem Battle - Quote Shoot

IRCTC tie-up with Paytm

“We have roped in Paytm for providing

maximum option to passengers for making

online payments. In the new age, we have to

offer passengers not only novel food options

but also more convenient payment

methods. The arrangement with Paytm is an

effort in that direction.”

–

Chairman and

Managing Director, IRCTC

IRCTC tie-up with mydala (deal aggregator)

“This tie-up will give millions of our

travellers and customers the benefit of not

just booking their tickets but also plan their

onward journey. It’s another step towards

IRCTC’s commitment to its customer’s

satisfaction.”–

Chairman and Managing

Director, IRCTC

SBI tie-up with Snapdeal

“The e-commerce growth has created a new

ecosystem enabling more than 5 lakh sellers

to sell product on digital platform. It has also

opened up opportunities for the banking

industry.”

– Chairman, SBI

SBI tie-up with Snapdeal

“The biggest challenge for SMEs is to raise

financing through formal banking is often they

don’t have collateral or a long history of financial

statements to give confidence to lender. Through

this real time analytics tool we have created with

SBI, we can assign a credit score to all sellers on

our platforms.”–

CEO, Snapdeal

HDFC Bank tie-up with Confederation

of All India Traders (CAIT)

"It is not enough to merely oppose the practices of

the e-commerce as the new generation is moving

online. We are also supportive of the government's

move to have a cashless economy and have

electronic payments."

– National Secretary General, CAIT

HDFC Bank tie-up with Confederation

of All India Traders (CAIT)

"The advantage for the trader is that they

will get the complete package, which would

not have been available to someone in the

unorganized sector."

– Head of Branch Banking and Co-Head

e-commerce, HDFC Bank

9 March 2016

Source: Various media articles

Financials – Digital Banking | Where's your money?

Even as banks build (and strengthen) their respective digital platforms, we believe

that the next 12-18 months will be all about acquiring customers and merchants to

populate their client base. Given the competitive intensity in customer acquisition,

banks will need to migrate the account opening process to the digital platform in

order to onboard customers quickly. The benefits of an easy-to-use, convenient

digital platform generally translate into customer migration towards the digital

channel. Exhibits 31 and 32 illustrate the digital shift in the Travel industry.

Within the Travel market, online penetration varies between 10% (in the case of car

rental services) to a range of 55-60% (in the case of air and rail travel). In fact,

adoption of e-ticketing in railway bookings has already crossed 55% as of March

2015 (Exhibit 32).

Exhibit 31: Penetration of online ticketing in Indian travel industry

56%

49%

41%

25%

17%

11%

12%

2013

48%

2016

Air

Rail

Hotel

Car Rental

Source: MakeMyTrip November 2015 filings, MOSL

Exhibit 32: Adoption of e-ticketing by commuters on Indian Railways

IRCTC E-ticketing

# of e-tickets (m)

# of passengers (m)

e-ticketing revenues (INR b)

Avg ticket size (INR)

e-tickets (% of total railway tickets)

2010-11

96.91

174.27

80.07

826.22

2011-12

116.18

209.99

94.98

817.55

>40%

2012-13

140.69

254.47

124.19

882.73

~45%

2013-14

157.98

279.50

154.10

975.43

50%

2014-15

183.02

328.85

206.21

1,126.70

55%

Source: IRCTC Annual Reports, MOSL

On the other hand, in the Entertainment sector, various industry publications claim

that the share of online movie ticketing (within overall box office collections) has

risen from ~5% (as of 2010) to over 30% (as of 2015) across India. In fact, the pan-

India 30% average is an aggregate of sub-20% online bookings in semi-urban centers

and over 50% online bookings in centers such as Mumbai and Delhi.

Basis these illustrations, we believe that customers are likely to increasingly adopt

digital banking channels when presented with user-friendly, convenient transaction

modes. We also argue that customers would largely be relatively price-insensitive

(willing to pay a premium for transaction convenience) as has been observed across

other categories.

9 March 2016

Financials – Digital Banking | Where's your money?

Rising digital maturity needs digital banking solutions

Consumers ‘on the move’ - hence, the need for ‘on-the-go banking’

1. Change in transaction mix

2. Why mobile banking

3. Impact on customer

lifecycle

An increasing proportion of the consumer’s decision-making is migrating to the digital

world with studies claiming Digital Influence Factor (DIF) at over 20% and Mobile Influence

Factor at 18%. With the number of smartphones expected to equal the number of active

bank accounts over the next five years, the need for digital banking solutions or apps that

enable ‘on-the-go’ two-way dialogue between a bank and its customers is self-evident. To

the extent that the RBI and banks have experimented with a few such business models, we

present early coverage and adoption trends from such alternate channels.

A recent study by Deloitte suggests that an increasing proportion of the consumer’s

decision-making process (beginning with awareness, followed by research,

comparison, choice and concluding with eventual purchase) is migrating to the

digital world. Digital Influence Factor (DIF) at over 20% and Mobile Influence Factor

(MIF) at 18% across product categories suggest consumers’ rising digital maturity.

As of December 2015, India has crossed the 1b mobile subscriber base (375m

mobile Internet users). With the number of smartphones expected to equal the

number of active bank accounts over the next five years (Exhibit 33), the need for

digital banking solutions that enable ‘on-the-go’ two-way dialogue between a bank

and its customers is self-evident. Annexure-II carries illustrations of a digital bank

interface that a customer could see by 2020.

Exhibit 33: Smartphone users to equal number of active bank accounts by 2020

Number of smartphones

expected to equal number

of active bank accounts

162

388 343

FY14

Number of non smart phone users

Number of active bank accounts

Number of smart phone users

224

389 387

FY15

304

364 434

FY16

386

477

467

525

291

FY18

550

577

243

FY19

625

629

195

FY20

332

FY17

Source: BCG Research, MOSL

Exhibit 34: Over 60% of online shopping in India happens on a smartphone

Over 60% of online

shopping in India happens

on a smartphone

Mobile website,

19%

Mobile app, 42%

Offline

Online

Desktop, 39%

Source: Media reports, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Our workings suggest that fast-tracking of financial inclusion can only be possible

and sustainable through the non-linear adoption of alternate, technology-enabled

channels by banks and customers alike.

Exhibit 35: Technological developments in financial services in India



First ATM

Deployed in

India in 1987



NEFT payments

launched by RBI

in 2005



Regulations

for Mobile

Banking

published by

RBI in 2008



Over 60m

MMIDs issued

by banks in

2014 and

INR32b of fund

transfer

1980

1985

1990

1995

2000

2005

2010



IMPS launched

for public by

NPCI in 2010

2014



First Credit card

launched in India

in 1980



Internet Banking

launched in

1990



Business

correspondents

allowed for

banks by RBI

2006

Source: RBI, MOSL

In fact, a plethora of start-ups (also called as fintechs) are focused on disrupting

some piece or the other within the financial services pie - from payments to

insurance to business lending to P2P lending (further details in Annexure III).

Exhibit 36: Mushrooming of fintechs in India

Source: BCG, MOSL

By issuing “differentiated licenses” to payments banks with varying business models,

the RBI has clearly taken a portfolio approach and stacked the bench. While this

offers scope for greater technology-based innovation and convenience for the end-

9 March 2016

Financials – Digital Banking | Where's your money?

user, it also means that the competitive intensity of the Indian banking sector will

shift to a completely new gear. After Annexure III, we capture excerpts from recent

interviews of incumbent banks on the impending challenges from fintechs.

To the extent that the RBI and banks have experimented with a few such business

models (Exhibit 37), we present early coverage and adoption trends from such

alternate channels.

Exhibit 37: Transaction mix by value - 2015

Payment Systems

Large-scale clearing

Paper clearing

Retail electronic

payments

RTGS

CCIL

operated

INR 752t

(45%)

CAGR:

14%

ECS

NEFT

Cards

Others

INR 754t

(45%)

CAGR:

14%

INR85t

(5%)

CAGR:

-(4%)

INR 3.8t

(0.2%)

INR 59.8t

(4%)

INR 25.4t

(1%)

INR 2.0t

(0.2%)

CAGR:

15%

CAGR:

71%

CAGR:

96%

Percentages adjacent to the value indicate corresponding share within the payments pie; CAGR refers to 5-year CAGR from 2010-15

Source: RBI, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Business correspondents

The Business Correspondent (BC) model, introduced by the RBI in 2006, is one of the

most significant policy initiatives that paved the way for branchless banking through

external agents. BCs are retail agents empanelled by banks to provide basic banking

services at locations other than a bank branch/ATM. BCs typically operate in urban

and rural areas where banks do not have branch presence. Given the nature of the

target segment, the business model is heavily reliant on technology - BCs use either

a smart card-enabled kiosk model or the mobile handset-based PDAs.

With the RBI tweaking norms to fix accountability and safeguard customers from

risks associated with BCs, the model has achieved reasonable maturity, dovetailing

into banks’ overall expansion strategy. Banks have significantly ramped up their BC

network - up 15x from ~35k touch points in FY10 to over 500k in FY15.

Exhibit 38: Business correspondents - despite wider reach compared to branches, could be commercially unviable

Branchless penetration in villages

Branches

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Branchless mode

Avg. ticket size per account (INR)

Avg. ticket size per outlet (INR '000)

Ratio of outlets: branchless to branch

FY10

33,378

737

1,328

34,316

806

312

1.0

FY11

34,811

792

1,663

80,802

576

226

2.3

FY12

37,471

1,353

2,932

141,136

184

3.8

FY13

40,837

1,634

4,033

227,617

224

5.6

FY14

46,126

2,169

5,925

337,678

334

115

7.3

FY15

49,571

1,736

7,363

504,142

397

148

10.2

BSBDA refers to Basic Savings Bank Deposit Accounts

Source: RBI Annual Reports, MOSL

Business correspondents

are hardly viable because of

abnormally low transaction

frequency

Converting a regulatory

obligation (financial

inclusion) into a viable

business opportunity

However, as we demonstrated in an earlier section, wider reach is inadequate in

itself if banks do not generate adequate returns from the derived opportunities. We

present HDFC Bank’s BC strategy as a case study on how a regulatory obligation

(towards financial inclusion) can be turned into a profitable business opportunity.

Case Study:

This illustrates how HDFC Bank uses the BC channel not only to achieve

financial inclusion but also to generate viable business opportunities. HDFC Bank has

appointed dairy societies as business correspondents, through whom the bank

opens individual farmer accounts. The bank has deployed Multifunctional Terminals

(MFTs) in dairy societies at villages – the MFTs link to the milk procurement system

and help facilitate payments (from the dairy) directly into farmer accounts on

payday. MFTs are equipped with cash dispensers that function like ATMs, enabling

withdrawals by the farmers. As a first-order derivative, HDFC Bank also uses the

payments flows data to offer credit products to farmers.

The most recent Economic Survey publication makes a case for enhancing financial

inclusion by developing the BC model further in terms of its profitability (possibly

raise the proportion of ICT-based transactions) and efficacy (raise the average

transaction ticket size).

9 March 2016

Financials – Digital Banking | Where's your money?

POS payment network

POS terminals - INR3.1t

(12% of the overall card

spend during FY15)

Concomitant with the empanelment of BCs, banks have also been investing heavily

in growing their electronic payments footprint via point-of-sale (POS) terminals

across merchant establishments. While the number of POS terminals has doubled

from 0.7m in FY12 to over 1.1m in FY15, the value of transactions being carried out

through debit and credit cards over these terminals has also risen proportionately

from around INR1.5t in FY12 to over INR3.1t in FY15.

Exhibit 39: Point of Sale (POS) terminals / transactions (FY12-15)

# of terminals (m)

Value of txn (INR b)

3,113

2,494

1,973

0.66

1,500

FY12

0.85

FY13

1.07

FY14

1.13

FY15

Source: RBI, MOSL

However, despite such growth, POS transactions accounted for only 12% of the total

card spend during FY15. In other words, 88% of the total card spend during FY15

was in the form of cash (withdrawals from ATMs). This is largely driven by the fact

that only 5-6% of Indian merchants accept digital payments. Hence, a significant

amount of groundwork is necessary to raise merchant penetration levels in order to

increase the proportion of digital card transactions.

Catalysts for the POS ecosystem

Over 35 entities, cutting

across large sectors such as

FMCG, banks, payment

networks, mobile network

operators and e-commerce

providers have partnered

with the GOI to drive

greater use of digital

payments at POS terminals

The Government of India (GOI) has now partnered with the United States Agency for

International Development (USAID) to launch initiatives that are specifically focused

on increasing the use of digital payments at POS terminals, particularly among low-

income consumers. Over 35 entities - cutting across six large sectors - fast moving

consumer goods (FMCGs), banks, payment networks, mobile network operators, e-

commerce providers, leading civil society organizations, and ecosystem players -

have partnered with the Ministry of Finance and the USAID on this initiative. The

objective of this partnership is to identify, test and scale innovative approaches that

will drive greater use of digital payments at the point of sale (POS).

9 March 2016

Financials – Digital Banking | Where's your money?

Prepaid payment instruments

PPI transactions – explosive

growth but less than 1% of

the overall transaction pie

The prepaid payment instruments (PPI) space has grown threefold from ~INR60b in

FY12 to over INR200b in FY15, largely due to the greater ease and convenience that

these instruments offer to a customer in carrying out routine payment transactions.

Among the PPI instruments, PPI cards have emerged as the most popular ones, with

non-bank PPIs fuelling a bulk of this growth.

Exhibit 40: Explosion in PPI transactions (INR b) – yet <1% of transaction pie

50.0

40.0

30.0

20.0

10.0

0.0

9.8

19.0

44.3

Source: RBI, MOSL

According to recent RBI publications, in less than 24 months, PPIs have contributed

to over 40% of all IMPS transactions between banks and non-banks connected to

IMPS switch. The RBI, in May 2015, also introduced mobility cards, a new category

of PPIs that are issued by mass transit operators.

Catalysts for Prepaid Payment Instruments (PPIs)

Our discussions with management consultants suggest that the government is

currently exploring options to link its Direct Benefit Transfer (DBT) payments to

either a prepaid card or a mobile wallet. There are global precedents where prepaid

instruments have been successfully used as part of financial inclusion efforts in

emerging economies such as Brazil and even developed countries such as the USA.

Recent reports suggest that

the DBT scheme for

distribution of government

subsidy could be

administered by India Post

In Brazil, for instance, Bolsa Familia, the social welfare program, has completely

moved its welfare disbursements from cash to electronic transfers on to prepaid

cards (debit cards). These ‘Citizen

Cards

‘ are administered by a government-owned

savings bank. A similar model is being explored in India with recent media articles

suggesting that the payment bank floated by India Post could be entrusted with the

distribution of the government subsidy.

As mentioned above, the RBI’s introduction of mobility cards to be issued by rapid

mass transit operators could also accelerate adoption and growth in PPIs.

9 March 2016

Financials – Digital Banking | Where's your money?

Internet banking

RTGS transactions at 45%

and NEFT transactions at

4% of the transaction pie

With advancement in technology and increasing Internet penetration, Internet

banking has emerged as the most convenient and a highly-used transaction channel.

In FY15, RTGS transactions accounted for 45% of the total transactions in value

terms while NEFT accounted for 4% of the total transactions.

Exhibit 41: Less than 2% of the population resort to NEFT transactions

# of NEFT users (m)

% of population (RHS)

1.52%

0.91%

0.52%

0.31%

FY11

FY12

FY13

FY14

Source: RBI, Deloitte, MOSL

During FY15, the banking system witnessed a monthly run rate of about 80m NEFT

transactions. Assuming a typical user makes an average of 3-4 NEFT transactions

every month, we derive the number of NEFT users at ~19-20m, which is less than 2%

of India’s population.

9 March 2016

Financials – Digital Banking | Where's your money?

Mobile banking

Of all the alternate channels that are being currently explored and experimented,

mobile banking holds the greatest potential in increasing reach for banks. Mobile

banking allows banks to serve customers on the move and is significantly more cost-

effective than traditional ‘brick and mortar’ banking.

Six-fold growth in mobile

banking transactions since

FY12 - yet only 0.1% of the

overall transaction pie

The exponential adoption of mobile banking as a transaction channel has happened

largely on the back of high (and growing) penetration and usage of smartphones,

especially in the metros and urban areas. This is evident in the exponential six-fold

growth in mobile banking from just over INR18b in FY12 to over INR1t in FY15.

Exhibit 42: Monthly mobile banking transaction value (INR b) - on a steep ascendancy

600.0

450.0

300.0

150.0

0.0

33.9

217.9

97.7

490.3

Source: RBI, MOSL

According to the KPMG Mobile Banking 2015 report, mobile is already the largest

banking channel (by transaction volume) for a majority of the banks globally. India,

with a mobile banking adoption rate at over 20%, is on the cusp of a quantum leap

in its mobile banking journey.

To put the mobile banking opportunity in perspective, the banking system currently

witnesses a monthly run rate of ~40m transactions over mobile banking. Assuming

an average of 5 mobile transactions per month by a mobile-savvy user, the volume

of mobile banking transactions indicates about 8m unique users that transact over

this mode. An RBI publication on mobile banking pegged the number of mobile

banking customers in India at 22m.

According to GSMA’s ‘The Mobile Economy India 2015’, India is the third-largest

smartphone market in the world and is expected to add nearly 500m smartphones

by 2020 (from the current base of ~185m smartphones currently).

9 March 2016

Financials – Digital Banking | Where's your money?

Channel-specific trends notwithstanding, our discussions with independent experts

and stakeholders in the business suggest that over the medium term, digital banking

will have a profound impact on the entire lifecycle of a bank-customer relationship.

Exhibit 43: The ‘digital banking’ wave

Source: Industry sources, MOSL

Banks have begun offering many day-to-day banking services such as payment

transactions, balance enquiries and account statements, invoicing and remittances

digitally. However, an end-to-end digital account that allows customers to open

accounts, operate them and conduct service transactions seamlessly for all products

remains elusive. We believe that the digital journey is at its first inflexion point and

the potential winners are likely to emerge from those that embrace innovation and

create new operating models.

9 March 2016

Financials – Digital Banking | Where's your money?

Breakthrough opportunities in Digital Banking

Digitization of government transactions; DBT; Analytics; P2P lending

We believe that the advent of digital banking will throw up explosive opportunities in

multiple areas including cross-sell, big data and analytics. Amongst these various elements,

we highlight three critical areas that we expect will emerge as potential game-changers by

2020: intra-government transactions; direct benefit transfers (DBT); and P2P lending.

Exhibit 44: Digital Banking - the ‘breakthrough opportunities’

Source: Industry sources, MOSL

Government transactions:

The JAM Trinity is considered as one of the biggest

reforms ever attempted by policymakers to help triangulate unique citizens of the

country for direct targeting of subsidy transfers. Hence, it is now obligatory for

government departments to become increasingly cashless in their internal as well as

external transactions. We expect government departments to begin adopting the

national e-payment gateway ‘PayGov India’ for collections over the next 12 months.

Direct benefit transfers:

The first cash transfer experiment (DBTL - DBT in LPG) has

resulted in near-zero exclusion of genuine qualifiers and ~24% savings to the

exchequer (savings of INR120b) from plugging of subsidy leakages. The Economic

Survey has now identified fertilizer subsidies for application of DBTs. A publication

by McKinsey (2013) suggests a potential saving of USD10b to the government from

digitizing welfare payments.

P2P lending:

Technology-based P2P (peer-to-peer) lending, although at a nascent

stage in India, is witnessing a flurry of activity. While companies such as iLend and

Faircent are beginning to create awareness amongst consumers, this remains an

unregulated sector that is beginning to attract the RBI’s attention and interest.

9 March 2016

Financials – Digital Banking | Where's your money?

Government transactions (transfers to / from the government)

The JAM Trinity is the confluence of three overarching themes that are currently

playing out in India: the Jan Dhan Yojana, the Aadhaar initiative and the Mobile

number. Given that JAM-enabled financial inclusion is one of the key priorities of

the Government, it is now obligatory for government departments and ministries to

become increasingly digital in their internal as well as external transactions.

As the Government of India embarks on its ambitious ‘Digital India’ initiative, the

idea is that all government departments, ministries and agencies should get to a

stage where they can collect and make payments electronically. According to a Draft

EPR Framework document from DeITY (Department of Electronic and Information

Technology), in a project being directly monitored by the PMO, the target is to move

at least 90% of aggregate receipts and payments online by the end of 2016.

As govt. payments become

electronic, working capital

requirements for India Inc.

could be transformed

A confluence of factors

(JAM Trinity and the

government’s willingness)

has created an ideal

platform for digital

transactions to and from

the government sector

Between the two legs of government transactions (receipts and payments), we

believe digitization of government payments could have disruptive ramifications for

the working capital requirements of corporate India.

Exhibit 45: Overview of government transactions

Source: Department of Electronic and Information Technology (DeITY), MOSL

Cabinet approval for

introduction of acceptance

infrastructure in

government departments is

a necessary first step in this

direction

A national e-payments system is a vital element in achieving India’s long-standing,

fundamental goals of financial inclusion and financial security for the poor and

relatively vulnerable sections of society. We believe that a confluence of factors (the

JAM Trinity and the government’s willingness) has created an ideal platform for the

digital transactions to and from the government sector.

A recent Cabinet approval (24

Feb’16) for introduction of appropriate acceptance

infrastructure in government departments and organizations is a necessary first step

in this direction. We expect government departments to begin adopting the national

e-payment gateway ‘PayGov India’ for collecting revenues, fees and penalties.

9 March 2016

Financials – Digital Banking | Where's your money?

Direct benefit transfers (DBT)

Results from the first cash

transfer experiment (DBTL -

DBT in LPG) suggest ~24%

savings to the exchequer

from plugging of subsidy

leakages

From the two most recent policy publications (the Economic Survey and the Union

Budget), it is clear that the JAM Trinity and Direct Benefit Transfer (DBT) are already

beginning to help plug subsidy leakages. Early results from the first cash transfer

experiment (DBTL - DBT in LPG) suggest near-zero exclusion of genuine qualifiers

and significant savings (~24%) to the exchequer (savings of INR120b, about 1% of

the total expenditure during 2015-16). Based on their observation of household LPG

consumption, the government is also actively thinking of reducing the household

cap (from 12 to 10). So, just on a single element of subsidy (DBTL), the government

is likely to save 3-5% of its aggregate expenditure.

The Economic Survey publication last week identified 2 more low-hanging fruits as

the most promising targets for further application of the JAM trinity - fertilizer

subsidies and within-government fund transfers. The Budget proposes introduction

of DBT on a pilot basis for fertilizers in a few districts (complete with a methodology

around cash incentives to be shared with the state governments).

McKinsey research suggests

potential savings of over

USD10b to the govt. from

digitizing welfare payments

- ~30% of the subsidy spend

budgeted for 2016-17

A recent publication by McKinsey (2013) suggests a potential saving of over USD10b

to the government from digitizing welfare payments, where payment inefficiencies

(a more diplomatic term for leakages to intermediaries) are as high as 30%. While

such estimates can often be approximations, a USD10b in potential savings is still

significant - translating to ~30% of the total subsidy spend budgeted for 2016-17.

Exhibit 46 captures an illustration of benefits from the DBT program in Centre-State

partnership schemes as evidenced in the pilot project for the MGNREGS (Mahatma

Gandhi National Rural Employment Generation Scheme) in Bihar during 2011-13.

Exhibit 46: Indicative benefit from DBT in schemes such as MGNREGA

FUND REQUEST

State

Component

Centre

Component

Panchyat

FUND REQUEST

CPSMS

(now)

PFMS

State

& Centre

Panchyat

Block

District

FUND RELEASE

Source: Ministry of Finance, MOSL

Under the earlier system, disbursals were based on forecasted expenditure and

funds sat idle in local government accounts until such expenditures were incurred.

Although MGNREGS has reformed its system at the national level following an

August 2015 cabinet note, most other government schemes continue to follow the

earlier system.

9 March 2016

Financials – Digital Banking | Where's your money?

Peer-to-peer lending - By the People; For the People

At this nascent stage, tech-

enabled P2P lending may

merit only soft-touch

regulation. However, this

category could be most

disruptive for banks with

large retail presence

Technology-based P2P (peer-to-peer) lending, although at a nascent stage in India, is

witnessing the highest amount of activity amongst fintechs (incorporation, funding

and transaction levels). While companies such as i-Lend and Faircent are beginning

to create awareness amongst consumers, they remain largely concentrated in

specific geographies. Although the sector may merit only soft-touch regulation in

the near-term, the P2P lending marketplace will be disruptive on both sides of the

balance sheet, especially for banks with a large retail portfolio.

The P2P lending business model is different from that of traditional banks in that the

P2P platforms don’t lend their own funds and hence, don’t need a balance sheet.

The P2P marketplaces are largely discovery platforms that merely match demand

(borrowers scouting for funds) and supply (creditors willing to deploy their surplus

funds). Each platform claims to build its own set of checks, balances and safeguards

to minimize the risk of borrower default. The platforms generate revenue primarily

from two sources: origination fees charged from borrowers (portion of the principal)

and servicing fee charged from lenders (portion of the interest).

Exhibit 47: Leading P2P Platforms in India

Source: Media reports, MOSL

Globally, P2P platforms have emerged as one of the most disruptive ecosystems for

traditional banks. As can be seen from Exhibit 47, established P2P platforms such as

i-Lend and Faircent are currently riding piggyback on the banks’ ecosystem (lenders

and borrowers necessarily need a bank account) and hence, do not strictly expand

the banking coverage universe.

Our discussions with players such as i-Lend and lenden in this space suggest that

their value proposition is centered on catering to the borrowing needs of the under-

banked population. The typical borrower in these P2P platforms is equipped with a

bank account but finds credit hard to come by at reasonable rates. Hence, the P2P

platforms are essentially targeted at borrowers that find bank lending inaccessible

and / or unaffordable due to their limited back-dated banking history.

P2P platforms in India are

largely targeted at under-

banked customers (and not

unbanked customers)

9 March 2016

Financials – Digital Banking | Where's your money?

RoA impact: “Dual Advantage” or “Double Whammy”

Revenue uplift potential greater than quick-win cost-optimization

As most leading banks launch their “own” digital platforms, we believe that banks could

see a two-fold benefit: (1) cost optimization from successfully migrating larger proportion

of customer transactions from physical channels to digital channels, and (2) revenue uplift

from technology-based cross-selling.

Channel migration is necessary…

In Exhibit 48, we present a cost-benefit analysis of the various transaction channels

to demonstrate one of the many low-hanging fruits from the banks’ perspective on

cost-efficiencies.

Exhibit 48: Payment instruments – a cost-benefit analysis

Payment instruments

and charges

Cheque

NEFT

RTGS

ATM transactions

Value of txns 3-yr CAGR Share of txn

(INR b)

(%)

pie (%)

85,434

59,804

754,032

22,303

-5%

49%

-5%

81%

2.4%

Avg ticket size

(INR)

~70,000

~65,000

> 10mn

~3,000

Charges (INR)

Processing costs (INR)

25-40 (large banks); 35-55 (small

banks

6-7 (per txn)

9-12 (per txn)

2.50-25

25-50

20-25 (after 5 free

8-16 (per txn)

monthly txns)

Source: RBI Bulletin Nov'15, Key Advisory Group report on Payment Systems, MOSL

As illustrated in Exhibit 48, banks incur disproportionately high processing costs in

paper clearance (cheques). Although the RBI-mandated cheque truncation system

(CTS), introduced in 2013, has reduced the cheque processing cost and time (a

digital image is transmitted to the paying bank instead of the physical cheque itself),

the cheque still remains the most expensive transaction instrument.

From the ticket-size analysis in Exhibit 49, we argue that small-value cheques

(constituting a bulk of the volume) can be migrated to NEFT (electronic mode). On

the other hand, large-value cheques (over INR100k) can be migrated to RTGS (which

is what even the RBI is nudging the banking system towards).

Exhibit 49: Ticket-size analysis for cheques

Ticket size analysis (INR)

< 10k

10k-50k

50k-100k

100k-500k

500k-1m

1m-2.5m

> 2.5m

Share of txn volume (%)

Share of txn value (%)

49%

33%

11%

26%

12%

30%

Source: Key Advisory Group report on Payment Systems, MOSL

Although banks often face customer resistance and inertia to channel migration

attempts, it is critical for banks to find ways to migrate customers from the “more

expensive” channels to “relatively less expensive” digital channels. This is especially

true in the case of customers who are less profitable to the bank. This also dovetails

into our second key takeaway around bank’s focus on customer profitability metrics.

9 March 2016

Financials – Digital Banking | Where's your money?

…but not sufficient

Transaction cost benefits

are largely a myth

While the cost-side optimization (cost per transaction) is a relatively quick win, we

argue that the long-term non-linear benefits will accrue to banks that are able to

successfully execute technology-based cross-sell. As we illustrate in the paragraph

below, the transaction cost benefits are merely capitalizing on one dimension.

Private sector banks such as HDFC Bank and ICICI Bank claim significant transaction

channel migration (~60% of customer transactions have already moved to the digital

channels). Although the cost-to-income ratio reflects the significant benefits of such

channel migration, we argue that the denominator (income) effect has not yet

accrued to these banks. As can be seen in Exhibit 50, a sharp shift in transaction mix

towards Internet and Mobile channels (a nearly 50 percentage point shift) over the

past decade has resulted in a substantial 10 percentage point improvement in HDFC

Bank’s cost-to-income (C-I) ratio.

Exhibit 50: HDFC Bank - transaction channel mix and C-I ratio (2005 v/s 2015)

FY05

Branches,

27%

Branches,

12%

Phone

banking, 4%

ATM, 53%

Internet &

Mobile,

63%

C-I ratio: 44.6%

Source: Company Presentation, MOSL

FY15

ATM, 21%

Phone

banking,

Internet &

Mobile,

13%

C-I ratio: 54.3%

While the cost per digital transaction (transaction conducted over a digital channel)

is meaningfully lower than the cost per transaction over a physical channel, the

transaction frequency under the digital mode is significantly higher than the physical

channel. To put this in perspective, a decade ago (or maybe even five years back),

customers may have visited ATMs for 1-2 large-value withdrawals (transactions) in a

month. Now, with the advent of Internet banking and mobile wallets, transactions

are relatively more frequent and of lower ticket size.

Exhibit 51: Transaction economics – no change in absolute transaction costs

Cost per transaction is

lower but high-frequency

transactions imply no

change in absolute costs

Transaction economics

Cost per transaction

Frequency

Total transaction cost

Physical channel

aXb

Digital channel

0.02a

50b

aXb

Source: Company, MOSL

In fact, our analysis of RoAs across the banking sector (Exhibit 52) demonstrates that

operating cost (in itself) is not a key differentiator of return ratios.

9 March 2016

Financials – Digital Banking | Where's your money?

Exhibit 52: RoA comparison (FY15) – top quartile banks v/s sector average

Top quartile banks generate

significantly higher income

than the sector average

ROA tree (% of total assets)

Net interest income

Non-interest income

Operating expenses

Employee expenses

Operating profits

3.37

1.72

2.22

0.92

2.87

Sector average

2.64

1.15

1.77

0.96

2.02

Note: Q1 refers to the top quartile banks; this exercise excludes foreign banks

Source: RBI, MOSL

As illustrated in Exhibit 52, the top quartile banks incur higher operating expenses

(despite lower employee expenses) compared to their peers within the banking

system. At the operating profit level, despite incurring higher operating costs, the

top quartile banks earn ~80bp higher compared to the sector average.

Although banks’ initial focus of digital activation is on channel migration (away from

employee-intensive branches), we argue that channel migration by itself is hardly

beneficial. Instead, banks need to start using the digital platforms to maximize

revenue-generating opportunities (smarter acquisition and smarter mining).

As customers begin migrating from branches to digital channels, banks will need to

learn to sell on these channels. For instance, even among private sector banks, a

random dipstick survey during the months of December and January revealed that

the customer-facing executives are extremely straitjacketed in their approach.

So, what will really move the needle?

The income component will

drive non-linearity in banks’

RoA improvement

Given that there is very little evidence of costs coming off meaningfully, we believe

the income component (the denominator in the conventional cost-to-income ratio)

will contribute almost entirely to the non-linearity in banks’ RoA improvement.

We believe that the rules of the game are about to undergo a paradigm shift in

terms of profitability metrics. Over the next five years, banks will increasingly focus

on customer profitability through metrics such as cost-per-customer and revenue-

per-customer. This will mean weaning away from the conventional cost-per-

transaction metric that currently prevails in the banking system.

From cost-per-transaction

to cost-per-customer and

revenue-per-customer

Exhibit 53: Paradigm shift in cost-to-income (C-I) measurement

#of employees /

100,000 customer

(Customer

acquisition)

Products per

customer (Minning of

extsting accounts)

Channel migration

(Minimal Employee

Assistance)

Transaction frequency

(Build Network

Externalities)

Source: MOSL

Cost per customer

(INR)

Cost-to-income (C-I)

ratio (%)

Revenue per customer

(INR)

9 March 2016

Financials – Digital Banking | Where's your money?

Increasing focus on cross-

sell and upsell capabilities

As a corollary, we argue that technology-enabled cross-selling and upselling will be

the biggest game-changer for banks over the next five years.

Exhibit 54: Products-customers matrix – another paradigm shift

New

TECHNOLOGY-

BASED CROSS-

SELLING

Product/

Business

Models

SMARTER TECHNOLOGY-

BASED CUSTOMER

ACQUISITION AND DIGITAL

ON-BOARDING

CHANNEL

MIGRATION

Existing

Customer/

Market segment

New

Source: MOSL

While the global cross-sell average ranges between 4 and 6 products per customer,

Indian banks average just over two products per customer. Banking literature

suggests that customer profitability zooms 6x (six-fold) for a doubling of the

products-per-customer. This is where we see significant scope for the Indian banking

system to benefit from non-linearity in RoAs.

Exhibit 55: Average number of products per customer with primary bank

Indian banks average ~2

products per customer

compared to the global

average of 4 products

2.6

Private banks

2.5

Foreign banks

4.0

2.1

Public banks

Global range

Source: BCG, MOSL

To put this in perspective, the two largest private sector banks earn annual third-

party fee income of about INR180 per customer. By contrast, the largest public

sector bank earns annual third party fee income of INR11 per customer.

9 March 2016

Financials – Digital Banking | Where's your money?

Why is cross-sell / upsell a MASSIVE opportunity for banks?

Government of India

looking to attach financial

services to Jan Dhan

accounts

Having championed the Jan Dhan campaign, the Indian central government is now

looking to attach a variety of financial services such as accident and life insurance

(and a pension product) to these accounts. With mutual fund penetration at 7% of

GDP and insurance penetration at 3.3% of GDP, banks are obvious “partners of

choice” for distribution of mutual funds and insurance products.

Having already rolled out the “last-mile” feeder for nearly 209m customers (under

the Jan Dhan campaign), banks will see an immediate benefit from float (that begins

appearing in these accounts), thereby converting some such accounts into genuine

flow accounts (from earlier levels of dormancy). As discussed earlier, transaction-led

float accounts offer banks the opportunity to earn fee income (independent of

business growth).

More critically, a customer’s savings habits over a reasonable period of time throw

up many asset-side opportunities (credit products) for banks. Banks should be able

to capitalize on business opportunities (both sides of the balance sheet) based on

the repository of analytics they build from the customers’ savings pattern. Most

importantly, cross-sell raises the stickiness of the customer – greater the depth of

the customer relationship with the bank, less likely is the customer to move away

from the bank.

However, while cross-sell and upsell are critical drivers of customer profitability, it’s

even more important to add the following two caveats:

a) Premature cross-selling (without adequate customer history within the bank) is

a high-risk proposition – this implies that every new customer relationship

should be allowed to ‘season’ before a bank begins to mine a customer further.

b) Cross-product platforms need to talk to each other – customer details need to

be consistent across platforms – it’s common to find a loan account that carries

a different customer address than the savings account for the same customer.

Banks are obvious “go-to”

channels for AMCs and

insurance firms

Cross-sell raises stickiness –

increases the probability of

“primary bank” relationship

CAVEAT:

Get the back-end cross-

platform technologies right

before cross-selling begins

Big Data and Analytics

As highlighted in the previous section, banks (and telecom companies) are by far the

biggest repositories of transactions and hence, consumer data across the world. We

believe that smart use of this data (through Analytics) contributes significantly to a

bank’s competitive advantage.

Post- the financial crisis,

banks understand the

importance of Analytics in

mapping the right product

to the right customer

Banks are typically exposed to structured (account-related) as well as unstructured

customer data from multiple sources such as social media and executive interaction.

All these isolated strands of data combine into the humungous volumes of Big Data

that is often the raw material for a bank’s decision making. Making sense out of this

Big Data is where Analytics play a mission-critical role. Post the financial crisis,

lenders have realized the importance of understanding a customer’s behavior across

multiple platforms to be able to map the right product to the right customer at the

most opportune time.

9 March 2016

Financials – Digital Banking | Where's your money?

The most basic application

of Analytics is in custom-

mapping relevant messages

(over any digital platform)

to existing customers

In the digital banking regime, the most basic application of Analytics is in custom-

mapping relevant messages (multiple forms of messaging) to an existing customer.

For instance, even with limited history of utility bill payments, banks can push

reminders to their customers closer to the payment due date. Banks could also look

at transaction patterns around a customer’s consumption to suggest and influence

the customer’s choice (high-frequency entertainment and travel). Banks could also

communicate exclusive offers (that are bundled with their own cards or net banking

services) to customers. Opportunities are abound – banks only need to put the

Analytics to use in a smart and selective manner.

As illustrated in the RoA tree in Exhibit 52 (on Page 38), top-quartile RoA-generating

banks have incurred significant costs (these are most likely front-ended investments

in technology and human capital). Over the next five years, these banks will need to

be smart about how they sweat their assets (customers, employees and technology

platforms). In this context, digitizing of transactions (an area that is receiving bulk of

the attention) is merely the tip of the iceberg, and in some ways, inconsequential.

The bulk of the value will be created when banks begin “thinking digital” across their

operations (from “customer acquisition” to “product fulfillment”).

The top-quartile banks

could expand their PPOP

spread over the system

average by 10-20bp by 2020

Our discussions with bankers and consultants suggest that the top-quartile banks of

2020 could very well witness an expansion of another 10-20bp in operating profit

spread over the system average.

Disclosure requirements

As banks begin making these changes to their internal processes and MIS metrics,

we argue that the best-practice public disclosures also need to undergo significant

changes. For instance, banks hardly disclose any granular customer segment-wise

qualitative or quantitative details – even in their Annual Reports. Even where there

are norms around disclosure requirements, cross-bank disclosures are hardly ever

consistent for the purposes of an intelligent comparison.

9 March 2016

Financials – Digital Banking | Where's your money?

Building a ‘Digital Quotient’ for banks

KMB, HDFCB emerge with early leads; SBIN among PSU banks

Having identified the key levers that are likely to shape the RoA trajectory for banks, we

use a broad set of quantitative and qualitative metrics to construct an industry-first,

proprietary ‘Motilal Oswal Digital Quotient’ (MODQ) for key banks in the system. Kotak

Mahindra Bank (KMB) and HDFC Bank (HDFCB) emerge as early leaders amongst private

sector banks while State Bank of India (SBIN) is a winner amongst PSBs.

At this stage, we have limited this exercise to seven large private sector banks and

the three largest PSU banks. If you are interested in a similar analysis for banks

outside this exercise, please get in touch with the author of this report or with your

relevant servicing manager in the sales team.

We construct the MODQ

around four categories –

scale, customer activity

levels, digital maturity and

banks’ product range

We build the MODQ around four distinct categories, which together encompass the

various parameters that are necessary for a successful digital banking business –

scale (number of customers), activity levels (savers v/s spenders), range of banking

products / services (cross-sell) and the digital maturity of customers (“channels”).

We subsequently construct specific metrics (of varying frequencies) to identify early

leaders within each category. Given the recent vintage of some of these metrics as

also moving parts around digital behavior and disclosures, we believe MODQ will

gradually evolve both in terms of its constituent metrics as well as lead indicators.

As with any other piece of statistic, a larger sample size (more data points across

metrics) will result in a more reliable MODQ over the next few years.

Exhibit 56: MODQ Framework - Summary snapshot

MODQ scorecard

AXSB

BOB

HDFCB

ICICIBC

IIB

KMB

PNB

SBIN

YES

Source: MOSL

Scale

Activity

levels

Digital

maturity

Product

capabilities

We present details of our MODQ methodology from Page 43 through Page 53.

Finally, starting Page 54, we also present our assessment of where each bank (in this

exercise) stands in its digital journey and its likely “beachhead” strategy, going

forward.

9 March 2016

Financials – Digital Banking | Where's your money?

Category I: Customer acquisition metrics

The entire RoA game hinges around achieving scalability. The size of the ecosystem

(customer base) plays a pivotal role in this exercise. To make this RoI-oriented, we

normalize each customer acquisition metric to an underlying core resource. For

instance, the number of basic savings bank deposit (BSBDA) accounts is mapped to

the number of business correspondents (BCs).

Exhibit 57: Category I: Customer acquisition metrics

Category I: Scale

# of individual customers added per employee

# of merchants added (POS) per branch

# of BSBDA accounts added per BC

% of BSBDA accounts that are Aadhaar seeded

Rank 1

BOB

HDFCB

IIB

KMB

Rank 2

SBIN

YES

Rank 3

PNB

AXSB

PNB

Source: RBI, PMJDY, Company Annual Reports, MOSL

Metric 1: Number of individual customers added per employee

Given the rising competitive intensity, banks are singularly focused on customer

acquisition at this stage. While the prevailing frontend-backend mix in the banking

industry is 1:2, we expect this mix to gradually reverse over the next decade, as

backend infrastructure gets automated and digitized. We use the employee base as

a denominator in this metric. We use the number of debit cards issued (debit card

base) as a proxy for each bank’s customer base.

Exhibit 58: Number of customers* added per employee

87.3

67.8

55.1

33.9

33.2

24.1

18.3

11.7

10.6

IIB

9.2

KMB

BOB

SBIN

PNB

ICICIBC

AXSB

HDFCB

YES

Note: * We use debit cards as a proxy for customer base. Incremental debit cards issued during FY15

Source: Company Annual Reports, MOSL

Basis our analysis of incremental debit cards issued during FY15, we find the PSBs

Bank of Baroda (BOB), State Bank of India (SBIN) and Punjab National Bank (PNB) as

the most prolific on the customer acquisition metric.

Metric 2: Number of merchants (POS terminals) added per branch

Nearly 70% of the consumer transactions (by value) in the payments space are C2M

(consumer to merchant) in nature. However, the number of Point of Sale (PoS)

terminals is far lower than the number of merchants in India, an indicator of the

abnormally high cash intensity in the country. Several small businesses deliberately

forego debit and credit card payments due to the upfront terminal setup costs and

as a tax avoidance measure.

9 March 2016

Financials – Digital Banking | Where's your money?

As policymakers tighten their fists around cash transactions, we believe that the POS

terminal penetration will rise rapidly over the next few years. We build this measure

to identify early leaders in the merchant acquisition space. Given that nearly 85% of

the POS penetration is in the Top 15 cities in India, we use the number of metro and

urban branches as a denominator to normalize the numerator (POS terminals).

Exhibit 59: Number of Point of Sale (POS) terminals per branch (Apr’15 - Sep’15)

181

134

105

BOB

PNB

IIB

KMB

AXSB

HDFCB

ICICIBC

SBIN

YES

Note: We have considered only the number of metro and urban branches in the denominator

Source: RBI, MOSL

From a stock-of-terminals perspective, we find Axis Bank (AXSB), HDFC Bank

(HDFCB) and ICICI Bank (ICICIBC) as the most prolific installers of POS terminals.

However, it is worth highlighting that ICICI Bank (ICICIBC) has been reducing its base

of POS terminals in absolute terms consistently since Oct’14.

Our analysis of incremental market share over the past 18 months (since March

2014) suggests that State Bank of India (SBIN) has gained market share at the cost of

ICICI Bank (ICICIBC). State Bank of India (SBIN), HDFC Bank (HDFCB) and Axis Bank

(AXSB) emerge as incremental gainers. While Kotak Mahindra Bank (KMB) does not

install POS terminals, the bank remains a prolific issuer of cards.

Metric 3: Number of BSBDA accounts per business correspondent

Under the RBI’s branchless banking initiatives, banks have also been partnering with

Business Correspondents (BCs) to bring the hitherto-unbanked sections of society

under the banking umbrella – by opening “basic savings” accounts. Basic Savings

Bank Deposit Accounts (BSBDA) are normal banking service accounts with common

facilities and features that are available to all but primarily targeted at the hitherto-

unbanked segments of the population.

Since this is not a statutory disclosure, the variables for this metric are not available

for all banks uniformly. Hence, we have relied on the limited survey data from CGAP

(Consultative Group to Assist the Poor), a body housed within the World Bank that

has been extensively working with BCs in India in the area of financial inclusion. At

this point of time, the observations from this metric are subject to a very small

survey sample size (N = 7,413 villages). Based on the limited disclosures by banks in

their FY15 Annual Reports and the limited survey data, we find IndusInd Bank (IIB),

Yes Bank (YES) and Punjab National Bank (PNB) as leaders on this metric.

9 March 2016

Financials – Digital Banking | Where's your money?

Metric 4: Percentage of BSBDA accounts that is Aadhaar-seeded

Given the financial inclusion-induced opportunities and the JAM trinity (explained in

pages 32 through 34), we include the proportion of such accounts that is Aadhaar-

seeded. This would essentially capture low-hanging fruits within BSBDA accounts

that involve least employee intervention in terms of benefit transfers and are most

likely to be beneficiaries of government benefit transfers.

Exhibit 60: Proportion of BSBDA accounts seeded with Aadhaar

61%

56%

47%

44%

43%

41%

38%

28%

19%

18%

KMB

YES

PNB

HDFCB

BOB

SBIN

ICICIBC

IIB

AXSB

Source: PMJDY - December 2015, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Category 2: Activity levels (proxy for quality of customer base)

As highlighted earlier in this report (Page 17), reach (by itself) is inconsequential if a

large proportion of customer accounts being added by the bank are dormant.

Hence, in this category, we capture the activity levels of the customer base.

Exhibit 61: Category II: Activity levels

Category II: Activity levels

Stickiness

Average balances in PMJDY accounts

% of zero-balance accounts

Average spends on POS terminals

ATM transactions per debit card per month

Rank 1

PNB

HDFCB

YES

Rank 2

PNB

HDFCB

BOB

IIB

KMB

Rank 3

BOB

HDFCB

KMB

HDFCB

Source: PMJDY, RBI, Company Annual Reports, MOSL

While the first three metrics in Exhibit 61 capture the customer’s propensity to save,

the last two metrics in Exhibit 61 capture the customer’s propensity to spend. We

believe that the metrics need to capture both dimensions (“propensity to save” AND

“propensity to spend”) of equal importance. While customers with high “propensity

to save” provide banks with float and float-led business opportunities, customers

with high “propensity to spend” offer banks transaction-led fee income

opportunities. We believe it’s critical for banks to have a healthy mix of both types

of customers (ones who save as well as ones who spend).

Metric 1: Stickiness

While scale is important, it is also important to assess the degree of a customer’s

stickiness with the bank. Post the financial crisis, banks have sought to build liability

relationship with the customer before mining the account for credit product(s). We

build a measure of stickiness of the deposit base using the following two metrics:

a) “Retail and small business deposits (RSBD)” as a proportion of the bank’s total

deposits – these are placed by individual customers and exclude bulk deposits;

and

b) “Stable deposits” as a proportion of RSBD – these are insured deposits to the

extent covered by DICGC in transactional accounts (auto-deposit or auto-credit

of salaries and pensions) or multiple-relationship accounts.

Exhibit 62: Indicator of deposit stickiness - FB and PNB lead the way

60.0%

PNB

45.0%

30.0%

AXSB

15.0%

YES

0.0%

20.0%

30.0%

40.0%

50.0%

SBIN

60.0%

IIB

BOB

ICICIBC

HDFCB

KMB

70.0%

80.0%

90.0%

100.0%

Note:

x-axis

denotes RSBD as % of aggregate deposits;

y-axis

denotes stable deposits as %of RSBD

Source: Company Annual Reports, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

A granular deposit base is considered relatively more diversified while a wholesale

deposit is more rate-sensitive, and hence, runs higher flight risk.

Federal Bank (FB) and Punjab National Bank (PNB) are the best positioned on this

metric, with high stickiness on both parameters. HDFCB and KMB have a granular

deposit base but suffer on the stability parameter. To break Exhibit 62 further, we

present the performance of these banks across both parameters separately in

Exhibits 63 and 64.

Exhibit 63: RSBD deposits (% of total deposits)

89%

71% 67%

66% 64%

59%

Exhibit 64: Stable deposits (% of RSBD deposits)

50%

46%

37%

32%

24%

19% 18%

16%

12% 10%

50%

41%

35%

30%

Note: RSBD deposits refer to Retail & Small Business Deposits

Source: Company Annual Reports, MOSL

Note: RSBD deposits refer to Retail & Small Business Deposits

Source: Company Annual Reports, MOSL

This metric is currently

subject to sampling error

and possible non-uniform

classification practices

across banks

Given the general perception on HDFCB’s high salary account penetration and cross-

sell capabilities (client mining), HDFCB’s performance in Exhibit 64 appears counter-

intuitive. Although we are convinced about the utility of this metric as a measure of

customer stickiness, we believe that the metric is currently subject to sampling error

(there is only one data point for the quarter ended March 2015) and possible non-

uniformity in classification practices across banks.

Metric 2: Percentage of zero-balance accounts

Given that the PMJDY initiative is aimed at bringing the hitherto-unbanked into the

banking domain with basic savings bank accounts that carry no minimum balance

requirements, a large proportion (31%) of these accounts carry zero balances as of

December 2015. In this context, we capture the bank-wise proportion of PMJDY

accounts that carry zero balances.

Exhibit 65: Proportion of zero-balance accounts (% of total PMJDY accounts) – Dec ‘15

HDFCB, BOB and PNB have

the lowest proportion of

zero-balance accounts

within the PMJDY accounts

15.9

21.8

56.8

40.7

44.2

46.7

56.9

33.2

34.5

36.1

PNB

BOB

HDFCB

IIB

AXSB

ICICIBC

SBIN

KMB

YES

Source: PMJDY, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

We believe this metric offers one proxy for the proportion of active PMJDY accounts

within each bank, especially given the nature of first-time banking customers. As of

December 2015, PNB, BOB and HDFCB outperform other banks on this metric.

Metric 3: Average balances in PMJDY accounts

Most banks have embarked on the Prime Minister Jan Dhan Yojana (PMJDY) in a

race to acquire customers that were hitherto unbanked. Despite no obvious

differences in the nature of the underlying accounts being added under this

initiative, there is a distinct divide in the average balances being maintained in such

accounts across banks. Some banks have significantly higher average balances in the

PMJDY accounts compared to others – we believe this is directly attributable to the

individual bank’s efforts in canvassing and educating customers about the long-term

benefits of savings.

Exhibit 66: Average balances in PMJDY accounts (INR) – cumulative position as of Dec '15

PMJDY account holders of

FB and HDFCB maintain the

highest average balances in

PMJDY accounts – a major

differentiator given similar

underlying target segment

3,166

3,104

1,735

1,159

1,054

945

793

757

662

494

HDFCB

BOB

AXSB

PNB

YES

KMB

SBIN

ICICIBC

IIB

Source: PMJDY, MOSL

In order to eliminate one-off performances, the scatter plot in Exhibit 67 compares

the bank-wise average balances maintained in PMJDY accounts as of December

2015 and the corresponding balances maintained in PMJDY accounts as of

December 2014.

Exhibit 67: Average balances in PMJDY accounts (INR) – Dec ’15 v/s Dec ’14

6,000

5,000

4,000

3,000

2,000

1,000

ICICIBC

IIB

500

1,000

KMB

SBI

PNB

AXSB

1,500

BOB

2,000

2,500

3,000

3,500

YES

HDFCB

x-axis denotes average balances as of Dec’15 while the y-axis denotes average balances as of Dec’14

Source: PMJDY, MOSL

FB and HDFCB are significantly ahead of other private sector banks while SBIN is a

clear laggard among the PSU banks.

9 March 2016

Financials – Digital Banking | Where's your money?

Metric 4: Average spends on POS terminals

This metric helps measure average spends on POS terminals (using either the debit

card or the credit card), a proxy for a customer’s “propensity for digital spending”.

We believe this metric is a proxy for the digital productivity of cards (whether debit

or credit) issued by a bank.

Exhibit 68: Average spends on POS terminals (debit and credit cards) (INR) – Apr’15-Oct'15

18,809

13,583

11,747

9,703

8,794

6,031

2,084

1,709

720

BOB

597

PNB

HDFCB

IIB

KMB

AXSB

ICICIBC

YES

SBIN

Source: RBI, MOSL

For instance, the average monthly spend on an HDFC Bank (HDFCB) card in POS

terminals is over INR2,600. On the other hand, the corresponding average monthly

spend on an State Bank of India (SBIN) card stands at less than INR300.

Metric 5: # of ATM transactions per debit card per month

Given that banks have capped the number of free ATM transactions per month, we

compare the average monthly debit card usage at ATMs for the leading banks.

Exhibit 69: Number of ATM transactions per debit card per month - Apr'15-Oct'15

2.7

2.3

2.2

1.9

1.7

1.6

1.0

0.6

YES

KMB

HDFCB

AXSB

SBIN

ICICIBC

IIB

BOB

PNB

Source: RBI, MOSL

As can be seen from Exhibit 69, Yes Bank (YES), Kotak Mahindra Bank (KMB) and

HDFC Bank (HDFCB) are the most prolific in usage of debit cards. For instance, a

reading of Exhibit 69 suggests that on an average, a debit card issued by YES is used

for 2.7 ATM transactions every month. Given that ATM transactions are generally

chargeable beyond the five free transactions that are allowed every month, a higher

average implies revenue-generating potential compared to a lower average.

9 March 2016

Financials – Digital Banking | Where's your money?

Category III: Digital maturity metrics

In this category, we evaluate the digital maturity of a bank’s customers from the

usage of alternate channels as well as early lead indicators from these channels.

Exhibit 70: Category III: Digital maturity indicators

Category III: Digital maturity

Mobile app rankings (Android)

Mobile banking market share

Cash intensity

Net RTGS transaction market share

Rank 1

KMB

SBIN

Rank 2

SBIN

ICICIBC

IIB

YES

Rank 3

HDFCB

Source: Google PlayStore, RBI, MOSL

Metric 1: Mobile app rankings (Android)

Using data and insights from Google PlayStore, we derive the net positive rankings

for the mobile banking apps launched by each of the banks in this exercise. We filter

the app rankings based on users with multiple mobile banking apps (users with just

single mobile banking app download are excluded). Using this as our universe

(denominator), we evaluate the percentage of net positive rankings (highest rating

MINUS lowest rating) for each bank.

For instance, in the case of Axis Bank, we have first adjusted the denominator for

users that have at least one other mobile banking app other than the Axis Bank

mobile banking app. On this denominator, we then derive the net positive rankings

(as % of the denominator). The numerator in this case is a proxy for the difference

between “recommenders” and “avoiders”.

Exhibit 71: Mobile banking app ratings (Android)

60%

52%

49%

41%

40%

38%

31%

22%

16%

KMB

SBIN

HDFCB

AXSB

ICICIBC

BOB

PNB

YES

IIB

Source: RBI, MOSL

We find Kotak Mahindra Bank (KMB), State Bank of India (SBIN) and HDFC Bank

(HDFCB) best positioned on this metric.

Metric 2: Mobile banking market share

In this metric, we plot the value of mobile banking transactions for each bank vs. its

savings deposit balance. Given the differing frequencies for both sets of variables

(the RBI publishes bank-wise mobile banking data on a monthly basis while the

savings deposits are reported by the banks on a quarterly basis), we assume a linear

change in the deposit base through a quarter.

9 March 2016

Financials – Digital Banking | Where's your money?

Exhibit 72: Mobile banking market share (% of savings deposits) - Apr’15 - Oct’15

6.6%

5.4%

5.0%

3.2%

1.9%

0.9%

0.4%

SBIN

0.1%

BOB

0.1%

0.0%

PNB

KMB

ICICIBC

HDFCB

AXSB

YES

IIB

Source: RBI, MOSL

We derive this as a percentage by using the monthly mobile banking transaction

value in the numerator and dividing that by the monthly savings deposit balance

(denominator) for each bank. Subsequently, we take the average of this ratio for the

period Apr’15-Oct’15. This metric indicates that over 6% of the savings deposit

balance is transacted over mobile banking in the case of Kotak Mahindra Bank. We

find Kotak Mahindra Bank (KMB), ICICI Bank (ICICIBC) and HDFC Bank (HDFCB) best

positioned on this metric.

Metric 3: Cash intensity

In this metric, we evaluate the customer profile of banks in terms of the customers’

cash intensity. For the purpose of this exercise, we categorize ATM transactions as

cash withdrawals and POS transactions as electronic. We calculate cash intensity as

the ratio of “value of ATM spend” over the “value of POS spend”. The higher this

ratio for a bank, the more cash intensive its customers.

Exhibit 73: Cash intensity (x) - Apr'15 - Oct'15

28.6

22.1

13.0

8.8

1.5

IIB

2.0

HDFCB

2.8

KMB

4.0

ICICIBC

5.1

16.3

AXSB

YES

SBIN

BOB

PNB

Source: RBI, MOSL

From Exhibit 73, we find that customers of IndusInd Bank (IIB), HDFC Bank (HDFCB)

and Kotak Mahindra Bank (KMB) are least cash intensive. For every INR1 spent on a

card (over a POS terminal), an HDFC Bank customer only withdraws INR2 from the

ATMs. As a proxy for customers’ transaction behavior, banks that are less cash-

intensive have a higher proportion of customers with propensity to migrate from

cash towards other channels.

9 March 2016

Financials – Digital Banking | Where's your money?

Metric 4: Net RTGS transaction market share

As part of this exercise, we plot the value of inward and outwards RTGS transactions

and the resultant market share for each bank. We derive the value of net monthly

inward transactions and transaction market share for every bank in this exercise.

The 10 largest banks, which

are part of this exercise, are

cumulatively losing ~3% of

their balance every month.

At the system-level, the value of all inward RTGS transactions equals the value of all

outward RTGS transactions. Hence, we believe that the net RTGS transaction market

share is a true and fair reflection of the bank’s transaction market share (over RTGS).

To put this in perspective, during the current financial year to date (April 2015 –

December 2015), the 10 largest banks, which are a part of this exercise,

cumulatively account for 54% of outward RTGS transactions and 51% of inward

RTGS transactions, implying that the large banks are actually losing nearly 3% of

their balance every month.

Exhibit 74: Net RTGS transaction market share - Apr'15 - Dec'15 (cumulative)

Did you know? HDFC Bank,

despite accounting for

~25% of overall RTGS

transactions, is consistently

losing RTGS transaction

market share

3.2%

-2.1%

-5.6%

-8.2%

AXSB

HDFCB

ICICIBC

-1.6%

-1.2%

-0.3%

-0.9%

-3.0%

-0.5%

IIB

KMB

YES

BOB

PNB

SBIN

Source: RBI, MOSL

The most interesting and counter-intuitive observation from this analysis is the fact

that HDFCB emerges as the biggest cumulative loser of balances, losing nearly 90bp

of transaction market share every month. On the other hand, State Bank of India

(SBIN) is the only large bank that has been a consistent winner, gaining nearly 40bp

of RTGS transaction market share every month.

Yes Bank (YES) and Federal Bank (FB) are other outperformers on this parameter,

where the value of funds flowing out of their customer accounts is broadly equal to

the value of funds flowing into their customer accounts.

9 March 2016

Financials – Digital Banking | Where's your money?

Category IV: Product capabilities

In this category, we evaluate the cross-sell capabilities for each bank to separate the

wheat from the chaff in terms of client mining abilities.

Exhibit 75: Product capabilities (cross-sell)

Category IV: Product capabilities

Credit-to-debit card ratio

Rank 1

HDFCB

Rank 2

KMB

Rank 3

IIB

Source: RBI, MOSL

Metric 1: Credit-to-debit card ratio

In this metric, we evaluate the credit card penetration within a bank’s customer

base. Since banks increasingly tend to begin new client associations with a liability-

side relationship, we use the debit card base as the customer base.

Exhibit 76: Credit-to-debit card ratio (%) (as of Oct’15)

31%

20%

17%

13%

11%

PNB

BOB

YES

HDFCB

KMB

IIB

AXSB

ICICIBC

SBIN

Source: RBI, MOSL

From Exhibit 76, we interpret that HDFC Bank (HDFCB) has issued credit cards to

over 30% of its debit card holders while the corresponding number for Kotak

Mahindra Bank (KMB) stands at 20%, an indicator of relatively better client mining

by HDFC Bank (HDFCB).

9 March 2016

Financials – Digital Banking | Where's your money?

HDFC Bank (HDFCB) | India’s very own Wells Fargo

HDFC Bank’s digitization initiatives are gaining significant traction, with nearly 2/3 of the

overall customer transactions happening through alternate channels. With its high account

activity levels, digitally mature customer base (30% market share in mobile banking) and

industry-leading ability to cross-sell, HDFCB is poised to capitalize disproportionately on its

operating leverage advantage.

Exhibit 77: PMI (Plus Minus Interesting) analysis

Highest installed base

of POS terminals at

over 270k (134 POS

terminals per branch)

High activity levels in

customer accounts:

Low share of zero-

balance accounts +

High average balances

+ High average spends

on POS terminals

Low cash intensity:

Cash intensity at 2.0x

during Apr'15-Oct'15

Low stickiness

(proportion of

transactional accounts

or multiple-

relationship accounts

is unexpectedly low at

18% of retail deposits)

Consistently losing

market share of 80-

100bp every month in

RTGS transactions

Industry-leading cross-

sell (credit-to-debit

card ratio at 31%)

Exhibit 78: Beachhead strategy

New To Bank (NTB)

strategy: On-

boarding of

customers using

digital channels

(smart acquisition)

Existing To Bank

(ETB) strategy:

Migrate physical

transactions on to

digital platforms

Increase transaction

sets available on

digital channels

Raise proportion of

digital cross-sell

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

State Bank of India (SBIN) | Could ‘Digital’ be the second wind?

State Bank of India (SBIN), India’s largest bank by reach and balance sheet size, enjoys the

unparalleled advantage of scale. Given the recent impetus to merchant acquisition, SBIN is

also now building a strong vendor ecosystem. With its powerful combination of scale and

network externalities, SBIN now needs to focus on raising the account activity levels and

encouraging channel migration (proportion of smart transactions) amongst its customers

in order to execute on its digital transformation strategy.

Exhibit 79: PMI (Plus Minus Interesting) analysis

Only large bank

consistently winning

35-40bp of RTGS

market share every

month

Rising POS penetration

(average at 34 POS

terminals per branch

by 1HFY16, up from an

average of 25 per

branch at end-FY15)

Very high proportion

of Retail & Small

Business Deposits

(RSBD) at 67% of total

deposits

Largest customer base

within the banking

universe (Debit card

market share at 29%)

Abnormally low

proportion of stable

deposits (only 12% of

retail & small

business deposits)

Low account activity

levels - proportion of

zero-balance

accounts is ~47%;

average balances are

less than INR800

High cash intensity

(13.0x as of Oct'15)

Weak client mining

(credit-to-debit card

ratio at just 2%)

Exhibit 80: Beachhead strategy

Scaling up of

merchant

acquisitions

(beginning to show

early results) -

acquired many top

educational

institutions and

hospitals

Minimize employee

intervention in

customer

transactions by

increasing the

number of daily

transactions through

SSKs (FY15: 55k)

6 Digital Banking

Outlets (DBOs)

opened under the

brand sbiINTOUCH

(targeted at Gen Y

and Smart Affluent)

Raise the share of

transactions through

the mobile banking

app 'State Bank

Anywhere'

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Axis Bank (AXSB) | Could G2C payments be the game-changer?

With a well-entrenched quasi-government legacy, Axis Bank (AXSB) is highly levered to the

digitization opportunity in government transfers. With the second-highest installed base of

POS (point of sale) terminals, AXSB has also positioned itself strongly in the merchant

market. Our analysis suggests that AXSB now needs to focus its energies on scaling up its

operations and raising activity levels in its customer accounts.

Exhibit 81: PMI (Plus Minus Interesting) analysis

Second highest installed base

of POS terminals (behind

HDFC Bank) at over 250k (181

POS terminals per branch)

Low activity levels in

customer accounts - low

average balances; low

frequency of ATM

transactions per month (less

than 2)

Financial inclusion (FI)

customer base of nearly 9m

Low proportion of cross-sell

(credit-to-debit card ratio at

just 13%) and relatively high

cash intensity (over 5.0x

during Apr'15-Oct'15)

Strong presence in G2C

payments (disbursed G2C

transfers of INR10b during

FY15)

Consistently losing 20-30bp of

market share in RTGS

transactions

Exhibit 82: Beachhead strategy

Existing To Bank

(ETB): Cross-sell to

internal customers

(two-thirds of

incremental retail

loans sourced from

existing deposit

customers during

FY15)

New To Bank (NTB):

Grow the rural loan

book

Consolidate and

grow the retail

payments and

remittances

franchise (C2C

transfers at over

INR39b during FY15)

Drive digital banking

penetration in

existing corporate

client relationships

to ring-fence them

from challenger

banks

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Kotak Mahindra Bank (KMB) | Go-to Banker for the Next-Gen

Kotak Mahindra Bank (KMB) has everything going for it - be it activity levels in customer

accounts, the digital maturity of its customers or its ability to up-sell and cross-sell to its

customer base. The only ingredient lacking in its architecture was scale - its acquisition of

ING Vysya Bank during CY15 seems to have plugged that gap considerably. KMB needs to

now fire on all cylinders and translate this digital advantage to gradually de-risk its retail-

heavy asset portfolio.

Exhibit 83: PMI (Plus Minus Interesting) analysis

High client mining

capabilities (credit-

to-debit card ratio at

over 20%)

No presence in POS

terminals (absent in

merchant acquisition

space)

High activity levels in

customer accounts:

High average spends

on POS terminals

Highest proportion of

zero-balance

accounts (57%)

Low cash intensity:

Cash intensity at 2.8x

during Apr'15-Oct'15

Highest proportion of

Basic savings

accounts (BSBDA)

that are seeded with

Aadhaar (61%)

Exhibit 84: Beachhead strategy

New To Bank (NTB)

strategy: Banker to

the next generation

with multiple digital

platforms including

over social media

(JIFI)

Existing To Bank

(ETB) strategy:

Migrate branch-level

transactions and

non-cash ATM

transactions to

digital platforms

Payment bank

partnership with

Bharti Airtel (300m

subscribers and 31%

market share )

Partner with fintechs

and position KMB as

a mobile-first

platform

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

ICICI Bank (ICICIBC) | Scattered too thin?

ICICI Bank (ICICIBC) has earned a reputation of identifying opportunities ahead of its peers,

whether it be retail banking (early millennium) or more recently, digital banking. However,

after all the hard work in acquiring clients, ICICIBC has been shedding merchants since mid-

FY15. Despite one of the best digital offerings in the system and very high customer recall,

we argue that ICICIBC now needs to focus its energies on monetizing its digital offering.

Exhibit 85: PMI (Plus Minus Interesting) analysis

High stock of installed base

of POS terminals at over

200k (100 POS terminals

per metro and urban

branch)

Consistently losing 50-60bp

of market share in RTGS

transactions every month

Consistently high mobile

banking market share (at

over 29% every month)

Poor client mining

capabilities (credit-to-debit

card ratio at 11%, lowest

among card-issuing new-age

private sector banks)

Digitally-savvy customer

base (moderate cash

intensity at 4.0x during

Apr'15-Oct'15)

Constantly rationalizing

installed base of POS

terminals since Oct'14

(shedding merchants)

Exhibit 86: Beachhead strategy

New To Bank (NTB)

strategy: Multiple

digital platforms

including bank-

agnostic platforms

such as Pockets and

transfer of funds

over Twitter through

icicibankpay and

Existing To Bank

(ETB) strategy:

Encourage mobile

banking as first port-

of-call (50% of

transactions

happened over the

Internet and mobile

during FY15)

Increase transaction

sets available on

digital channels

Focus on social

media to grab

disproportionate

share of next-gen

customers

(youngsters)

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Yes Bank (YES) | Merchant acquisition = Higher Current Account

Market Share

While the rest of the system has been obsessed with building a savings account franchise,

Yes Bank (YES) has focused its efforts entirely on acquiring merchants and building a strong

current account (CA) franchise as its moat. YES now needs to disproportionately

participate in the e-commerce opportunity to quickly monetize its vendor footprint.

Exhibit 87: PMI (Plus Minus Interesting) analysis

Rapidly expanding

installed base of POS

terminals (30 POS

terminals per metro

and urban branch)

Highest proportion of

zero-balance accounts

(57%) and low activity

levels in customer

accounts

Largely neutral-to-

gaining market share

in RTGS transactions

every month

Low proportion of

basic savings accounts

that are seeded with

Aadhaar

Highest frequency of

ATM transactions

per month (average

usage at 2.7 per

debit card for

Apr'15-Oct'15)

Low proportion of

stable deposits (at

10% of retail deposits)

Highest cash intensity

among new-age

private sector banks

at ~9x during Apr'15-

Oct'15

Exhibit 88: Beachhead strategy

New To Bank (NTB)

strategy: Positioned

as primary banker to

merchants (on-

boarding of

merchants using

Internet Payment

Gateway)

Existing To Bank

(ETB) strategy:

Migrate physical

transactions on to

quasi-digital

platforms such as

Yes2Call

Grow market share

in the e-commerce

market

Ecosystem tie-ups

with fintechs to

create network

externalities and

leapfrog early

movers

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Federal Bank (FB) | The Dark Horse - High on float but low on

transaction frequency

Federal Bank (FB), the largest among the old private sector banks, with its catchment of

NRI customers, demonstrates the highest account activity levels within the system (highest

deposit stickiness and highest average balances in PMJDY accounts). While the bank enjoys

a significant share of its customers’ savings pool as a primary bank, we argue that FB does

not partake meaningfully in its customers’ spend. With cash intensity at over 16x, FB needs

to now focus on positioning itself as its customers’ primary transaction banker.

Exhibit 89: PMI (Plus Minus Interesting) analysis

Highest stickiness of

deposits (industry-

highest proportion of

retail and small business

deposits at 89% of total

deposits)

Low average spends (POS

spends average less than

INR250 per month)

High proportion of stable

accounts (46% of retail

deposits are either

transactional or multi-

relationship)

High cash intensity (16.3x

during Apr'15-Oct'15)

Highest balances in

customer accounts

(PMJDY accounts)

Limited product

capabilities (does not

issue credit cards)

Exhibit 90: Beachhead strategy

New To Bank (NTB)

strategy: On-

boarding of young

customers using

digital channels (50%

of HNI customers

acquired during FY15

under the age of 40)

Existing To Bank

(ETB) strategy:

Running reconnect

and outreach

programmes to

engage existing

customers (300k

customers shoring

up balances to the

Existing To Bank

(ETB) strategy:

Migrate non-cash

enquiries on to

FedBook, the digital

pass book

Separate mobile

banking strategy to

migrate from mobile

banking app to a

platform-based

solution

Source: Company, MOSL

9 March 2016

Financials – Digital Banking | Where's your money?

Annexure I - The Focus on Digital (Annual Report collage)

9 March 2016

Financials – Digital Banking | Where's your money?

Annexure II - Illustrations of a possible digital interface by 2020

Tab-based summary

viewable over a

smartphone

Location-based offers (NFC-

based merchant offers)

Callable transaction history

and reminders (based on

analytics around

transaction history and

social media accounts

linked to the customer

accounts)

9 March 2016

Financials – Digital Banking | Where's your money?

Annexure III – Emerging fintechs landscape in India

9 March 2016

Financials – Digital Banking | Where's your money?

Silicon Valley vs. Wall Street - Global context

On the Future of Finance

“We use technology to make it cheaper,

better, and faster for the client. And then if

you have the most flow, you can win. Now,

having said that, Silicon Valley wants to take

on this business.”

Application of Big Data

“Let’s look at lending, where they’re using

big data for the credit side. And it’s just

credit data enhanced, by the way, which we

do, too. It’s nothing mystical. But they’re

very good at reducing the pain points. They

can underwrite it quicker using - I’m just

going to call it big data, for lack of a better

term: “Why does it take two weeks? Why

can’t you do it in 15 minutes?”

Excerpts from Bloomberg Markets interview with

Jamie Dimon on Finance: ‘Who Owns the Future?’

Regulatory arbitrage

“It might be harder for us to charge a higher

interest rate, like they do, so it might not be as

profitable for us. But we can either compete or

partner, like we’ve announced with On Deck, which

does some of the stuff we just spoke about.”

Risks for fintechs

“The biggest risk will be in the payment

systems. I think the banks are pretty good at

using digital technology to make it easier for

customers. We have 23 million customers

who bank on their phones now. It will be a

challenge for anyone to be better, faster

and cheaper than us. But some people think

branchless banks can compete, and that can

prove true in some cases.”

Risks for fintechs

“One of the issues with some of these lenders is

going to be, where will their provider of credit be

when there’s a crisis? That’s why some of these

smarter services, to support their operations, are

courting more permanent capital. They want a

source of longer-term funding that can survive a

crisis.”

Regulatory arbitrage

“I think the regulators want to make sure

that they have some form of regulation on

anything systemic. We like our hand. But,

you know, honestly, who owns the future?

Just because you have a good hand today

doesn’t mean it’s good tomorrow. And some

of the things we’re doing may become very

disadvantageous at some point.”

9 March 2016

Financials – Digital Banking | Where's your money?

Silicon Valley vs. Wall Street - Closer home

On rising competitive intensity

“I do believe that this is clearly an era of

paranoia and not an era of complacency.

Every one of us, including banking and

financial services, needs to live on the edge

because the level and speed at which

change is happening is phenomenal.”

Mortality of financial institutions

“In the Indian banking and financial service

industry, thanks to the regulator and the

government, so far we have not had any mortality.

We have not seen any death. But as we see 21 new

banks, including the new two banks that have

come in, plus the existing banks, how ready is the

Indian political, social and civil society to deal with

the other side of competition, which is mortality? If

you have competition, there will be blood.”

Value of franchise

“We have always operated in a competitive

environment. But to create a franchise, a franchise

in scale and sustained customer relationship, it

takes time, investment and efforts. The existing

players have the advantage of having created a

franchise, but they are required to remain nimble.

The new players start with a clean state, but have

to work hard on execution.”

Innovation by incumbents

“Innovation does not always have to be one big step.

Innovation is also the step changes that you make

every day to improve your products, services and

how you can deliver better value. Everything around

the use of data will be a big game-changer. We can

still do more in the area of data analytics, not just to

offer more products to the customer but also look at

options to create a history of credit around an

individual customer.”

Rising competitive intensity - get ready for mortality

“What we need to understand is there is a fundamental

change with the convergence of telecommunication and

media; the power has shifted to the consumer. But

frankly, nobody has a monopoly in this market. The

network has changed the way customers are likely to

behave. The key is convenience, pricing and trust. We

give a loan in 10 seconds. We give a top-up loan at the

press of a button. In an ATM, we can give a loan. I don’t

think the change is threatening. If you change your

model and have the scale to be lower cost, I think they

are in for a great time. Will there be blood on the street?

Yes.”

Innovation by incumbents

“There are earth-shaking innovations that have

happened in the last few years, but

fundamentally, we are here to get these

services for our customers with the technology

available to us. We will change the way we do

credit, the way we service our customer, the

way we market, and at the end of it, you will

change your model to becoming more low-cost,

more effective and serving customer needs

better. Frankly, that is all we need to do.”

Regulatory arbitrage

“There is too much obsession with the word ‘bank’. I think

we are moving into a world of financial intermediation. The

customer is saying that as long as I am getting products and

service from a financial intermediary I trust, that is value. The

future is efficient intermediation. There are three crucial

points which will affect financial intermediation. First is the

increased importance of brand and trust. Second is moving

away from cross-subsidisation like mandatory government

bond-holding. We must consider the option of financial

technology companies also buying into some of these

government bonds. Third is good regulation, where

regulators need to move away from expecting multiple

objectives from banks.”

Could there be enough for everyone?

“The pie is large. I think there is a role for all banks to

play and get into the pie. There is still a lot of

untapped opportunity in this country, especially in

retail and inclusive financing. The payment banks are

such that they cover a very niche area. The revenue of

the payment in total banking revenue is hardly 5-7%.

The rest is all from other banking services. Small

finance banks will have to be very sure of what

lending should be done.”

9 March 2016

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