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ICICI Bank (NYSE:IBN) was often showcased as the poster boy of the Indian economy's supercharged growth in the 2003-08 period. While the Indian economy growth story is back on track after a one-year hiatus, it's probably going to take a little longer for ICICI Bank.

In the recently concluded 2010 fiscal year (March 2010), the Bank's total unconsolidated income (excluding insurance and other subsidiaries) declined ~12% to INR 332 billion. The decline in interest income (~20%) was the main factor behind the income decline. ICICI had focused on reducing its retail and unsecured lending book and that is reflected in the ~20% decline in customer advances to INR 1.8 trillion (~$ 40 B at current exchange rates). Lower interest rates coupled with a reduction in the loan book led to the decline in interest income. However, operating profit increased by ~10% to INR 97 billion, thanks to the cost-control measures undertaken, and that reflected in the 10% increase in net profits.

Peers Are Leaving ICICI Behind

The problem with these numbers is that they pale in comparison with peers. HDFC Bank (NYSE:HDB), its closest private-sector-banking rival, has had flattish interest income between 2009 and 2010 fiscals, but its net interest margin (NIM) is ~3.4% against ICICI Bank's 2.5%. While ICICI shrunk its customer loan book, HDFC had a whopping 25% increase in customer advances and also maintained its lead on the NIM front. The point to note is that the loan book growth in 2009 has been despite more conservative lending norms followed in 2009 compared to the more growth-focused lending in the 2005-08 period. Clearly as NPAs hit the loan book, ICICI Bank hit the brakes on loan growth while HDFC has filled the vacuum.
With advances totaling INR 1.2 trillion, HDFC is still much smaller than ICICI Bank but it could well challenge ICICI in the years ahead despite its 'conservative growth' focus. If, despite its conservatism, HDFC can grow its loan book 25% and its NIM is industry-leading, clearly it's doing things right.

Further on the NPA front, HDFC has a net NPA ratio of 0.6% while ICICI has a net NPA ratio of 1.9% and that speaks of the difference is asset quality between the two firms. All this means that ICICI will be more cautious in growing its retail loan book (where it had the maximum issues). HDFC has had no such problems,

Quality Of Loan Book - What The Numbers Will Not Tell

But what these numbers will not tell is what's been the quality of the advances that have been added in 2009 and early 2010. While the reduction in NPAs do indicate that overall quality of the loan book has improved, there are other important qualitative factors that need to be considered :

  • For ICICI, home loans constitute 60% of the retail loan book, which in turn constitutes 43% of the total loan book. ICICI was reducing its exposure to this market at a time when home affordability was its best (in 2009) in the last 3-4 years in terms of the home value/consumer income ratio.
  • Asset prices have India, especially homes, have started to increase irrationally again in 2010 and so ICICI might find it difficult to grow its loan book with the more conservative lending norms that it has in place now.
  • HDFC and other public-sector banks have reaped the benefit of ICICI's lack of aggression in 2009 in the retail segment
  • While India's central bank has fixed a 20% credit growth target for fiscal 2011, the huge liquidity available in the system suggests that there could be stiff competition among banks that go after credit growth.
  • Despite consumer inflation being in double digits persistently, it looks unlikely that it will cool off in the months ahead. This might naturally lead to a increase in interest rates and reserve ratios, and credit growth might be affected with the double whammy of increasing interest rates and higher asset prices

Competition Has Caught Up And ICICI Needs to Forge Ahead

In summary, ICICI might have well missed an opportunity to increase its dominant position in the retail lending landscape in India. While prudent lending norms are definitely needed, it doesn't mean that growth should be curtailed, as HDFC has shown over the last year. If ICICI lags behind other Indian bank peers in advances growth in fiscal 2011, one poster boy of the Indian growth story will be replaced by many other worthy contenders. ICICI is still perceived as a growth story, and we do hope it stays that way.

Disclosure: Long IBN