Concentrated, Yet Fragmented — Indian Banking Has A Split Personality

The merger between India’s largest private bank HDFC Bank Ltd. and India’s largest mortgage financier Housing Development Finance Corp. Ltd. has sparked chatter about greater concentration in the banking sector.

HDFC Bank, already the second-largest bank after the mammoth State Bank of India, will command 16% market share of the banking sector’s advances compared with 11.5% before the merger. This adjusts for the additional advances on HDFC's book being included in the banking sector.

SBI controls 23.7%. In a post-merger scenario, the two will together control 38.5% of the market.

This suggests a relatively high degree of concentration in the banking sector. But, is that really the case? Yes and No.

A BQ Prime analysis of market share data over the decades suggests that while the Indian banking sector has always been concentrated at the top, it is fragmented beyond that.

The data for 2005, 2010 and 2020 is computed from information available RBI's database on the Indian economy. Data for 2022 is compiled using individual bank releases and RBI data on outstanding bank advances.

Let’s start with 2005. Give or take a few years, this was a decade from the point when private banks were given a free run in the banking sector.

In this year, State Bank of India and its associates together held 24.7% of the banking market. Nationalised banks held another 49.5%.

This left private banks with a 19.3% share, with ICICI Bank Ltd. holding the lion’s share at 7.9%. Remember, ICICI Bank had a life before it became a private bank and in some ways had a headstart. HDFC Bank, a decade into its existence, held 2.2%.

As such, the top two banks in 2005 were SBI (we are using the consolidated number for SBI and associates) and ICICI Bank. Together, they commanded 32.6% of the banking market in 2005.

In 2010, things weren’t very different for SBI, which held on to its share at 24.5%. ICICI Bank’s share went down to 5.18%, with HDFC Bank sniping at its heels and capturing 3.6% of the market. In this year, it was actually Punjab National Bank which was the second largest bank by a small margin, controlling 5.33%.

So together, the top two lenders saw their share fall to 29.8%.

The top two became stronger again by 2020 as HDFC Bank galloped away with the market share as others consolidated in the aftermath of the global financial crisis. Together, SBI, with a slightly reduced share of 22.57% and HDFC Bank with a share of 9.6%, cornered 31.2%.

In 2022, before the merger, these two lenders controlled 35.2% of the banking system’s advances.

Larger banks are better for the system, said Ashvin Parekh of Ashvin Parekh Advisory Services. A larger and more diversified portfolio allows banks to withstand economic cycles better. Parekh points out that these lenders may command a large share and their portfolios cover lending to a host of sectors.

If you look beyond the top two, though, the banking sector's personality morphs.

In 2005, the 10 largest banks collectively held 63.9% of advances. Without the top two, though, the share of the next eight largest banks was 31.3%. The individual market share of these banks ranged from 2.4% to 5.25%. Incidentally, each of these were public sector banks. HDFC Bank, the second largest after ICICI Bank among private lenders, was then at number 12.

There wasn’t much change over the next five years.

In 2010, the top 10 banks held 63.57% market share and, excluding the top two, the next eight lenders held 33.7%. ICICI Bank and HDFC Bank were the only two private banks in the top 10, although Axis Bank Ltd. was coming close at number 11, with a share of just under 3%.

The decade of 2010-2020 is where much of the reshuffle in the banking sector happened. It was a time when public sector banks were forced to consolidate as bad loans mounted. It was also the decade when Kotak Mahindra Bank Ltd. merged with ING Vysya.

As a result, the league tables shifted considerably.

As of March 2020, the share of the top 10 banks rose to 68.27%. The share of the eight, aside from SBI and HDFC Bank, rose to 36%. But only three of these banks had more than 5% market share. Four private banks–HDFC Bank, ICICI Bank, Axis Bank and Kotak Mahindra Bank–were in the top 10.

In a relatively short two years, the top 10 banks have strengthened their lead. They now command 80.9% of the market. The eight lenders that follow SBI and HDFC Bank now hold 45.7% of the market.

Market share for 2022 has been computed using data from earnings releases and comparing it to the RBI data on outstanding bank credit for scheduled commercial banks as of March 25.

One big reason for this is the merger of PSU banks, which became effective April 1, 2020. This had led to an increase in share of the merged banks. But even beyond that, lenders like ICICI Bank continued to grow when the market was consolidating, pushing up its share of advances.

Saswata Guha, head of financial institutions for India at Fitch Ratings, said that barring SBI, only HDFC Bank has a double-digit market share, he said. The rest hold between 3% and 6%, which can hardly be deemed as concentrated, Guha said.

Guha added that it is not unusual for large, growing economies to have a few large banks at the top (or pillar banks) to support the growing needs of an expanding economy and corporate sector. These can then be supported by a smaller set of banks which cater to the middle and lower order of borrowers, he said.

"In that context, we believe consolidation is a long-term positive for the sector as it will allow more efficient and effective credit delivery."

Parekh agreed. There are no signs of greater pricing power for the large banks given that the number of banks and financial institutions in India is large, he said.

India also continues to have a number of lenders who hold less than 1% market share.

In 2005, over two dozen local banks had a market share of less than 1%. This had reduced to 14 by 2020. Post the PSU bank mergers, based on last available numbers, 12 listed banks have a market share of 1% or less.

We exclude foreign banks here since a number of them operate through representative offices and don’t have large local balance sheets. We also exclude differentiated banks, such as small finance banks and payment banks, which have been introduced relatively recently.

Smaller banks find it tougher to grow and are subject to more volatility due to limited scope of operations, said Parekh. One bad cycle could mean a two to three-year setback for individual lenders, he said.

Still, they have a role to play in the economy.

"Banking is a relationship-driven business, so smaller banks do have a role in supporting local economic activity and in broadening the base of bankable customers," said Guha. "But they too suffer from high competition (including from non-banks), and are limited by the scope of their regional presence, unless say they are specialised in some niche product segment (such as microfinance) which can help mitigate some of the growth constraints."

Guha added that these banks could be seen as merger candidates as bigger banks look to penetrate into lower tier cities. Larger banks can make good use of the regional/borrower know-how of the smaller banks, which can make the latter potential acquisition targets, he said.

"Our view is that we will see more mergers in times to come. On last count, India still had about 90 banks, of which foreign banks are roughly 45 (mostly operating as bank branches), while the rest are licensed SCBs, which is still a lot of commercial banks," said Guha.