Will the real SBI please stand up?

NOBODY BELIEVED IT AT FIRST. On May 17, the State Bank of India (SBI) announced that its net profit for the quarter ending March 31 had fallen 99% to Rs 21 crore. Even before the management of India’s oldest (205 years) and largest (Rs 12 lakh crore in assets; ranked third in the Fortune India 500) bank had a chance to explain why at an earnings conference later in Kolkata, business channels went into a tizzy, investors nearly threw up their lunches, and the stock closed at Rs 2,413 on the Bombay Stock Exchange (BSE), down 8%, intra-day, and off 10% from the beginning of the month. It would slide further and it’s only since July that it’s returned to the Rs 2,400 levels. An SBI director later confided to Fortune India that the “results took all of us by surprise; we had not anticipated it”.

A chunk of the quarter’s profits had gone to provision for a special home loan scheme that the Reserve Bank of India (RBI) had indicated as high risk by a fivefold increase in the provisioning requirement for such loans. The bank’s provisions for nonperforming assets (NPAs) had also gone up by 75% for the quarter due to the change in provision coverage ratio for NPAs.

At the conference, SBI’s chairman Pratip Chaudhuri, who had taken over barely a month earlier, said, “At the last annual results, someone had asked if SBI had ever reported a drop in net profits. We could not recall any such time. This year we have a drop in the profits.” While fielding questions from analysts for over two hours, he stressed how the bank was cleaning its books so that the NPA issue wouldn’t extend into the future. Gross NPAs were at Rs 25,326 crore for financial year 2010-11, up 30% from the previous fiscal.

Over the next few months, at routine interviews to newspapers and TV channels on topics such as interest rate movements or macroeconomic trends, Chaudhuri began hinting at the bank he was trying to build: one that does not grow market share at the cost of profitability, is focussed on improving its financial ratios, conservative in its provisioning, and, most significantly, not “in a perpetual state of conflict with the regulator [the RBI]”.

Though Chaudhuri never makes it explicit, it’s as if he is trying to distance himself from his predecessor, Om Prakash Bhatt, SBI’s chairman between July 2006 and March 2011, who more than doubled the size of the bank and is seen as its most audacious and aggressive head ever.

In keeping with his low-key approach, Chaudhuri didn’t meet Fortune India despite two months of continued efforts. He is reluctant to be in the spotlight. As chairman, Bhatt was nearly always in the media. “Unlike Bhatt, whose high profile raised eyebrows, especially at the finance ministry, Chaudhuri is the more conventional public sector head—self-effacing and somewhat reclusive,” says a senior executive who knows both. Indeed, Chaudhuri has even avoided ceremonies meant to felicitate him.

Bhatt declined to speak as well, saying he did not wish to “further damage” the reputation of the bank. He made one admission though—that SBI has completely changed tack since he left. That was just five months ago.

Fortune India spoke to nearly three dozen people, including RBI officials, SBI directors and senior executives, former employees, rival bankers, customers, consultants, analysts, and bureaucrats. Nearly all spoke off the record and the majority described recent events as an identity crisis for the bank, going beyond individuals. “It’s about what SBI stands for. The past few months have just brought the issues into the open,” said one observer.

A former chairman of Bank of India (India’s fifth-largest bank), with over four decades of banking expertise, says that just as private airlines haven’t done away with the need for a national flag carrier or courier services haven’t obviated the need for India Post, SBI’s role continues to be relevant. “What that role is, to what extent it’s going to be changed for macroeconomic requirements, and to what extent it can compromise on commercial aspects, are areas where it needs to introspect,” he said.

CHAIRMAN’S OFFICE, 18th FLOOR, SBI HeadQuarters, Nariman Point, Mumbai. Nearly six months before Bhatt moved into this mammoth room, ICICI Bank had upstaged SBI as India’s most valuable bank. On December 23, 2005, its market cap on the BSE was Rs 50,831 crore—Rs 3,878 crore more than SBI. (Till January 2008, it would stay that way.) ICICI’s balance sheet was about half of SBI’s, but growing between 40% and 50%, compared with SBI’s 13% to 15% growth. A former SBI executive says he prepared a spreadsheet for Bhatt, showing that if both banks maintained those rates, ICICI would overtake SBI within five years. “Bhatt would have had the unfortunate privilege of seeing SBI become No. 2 under his tenure,” he says.

Bhatt had spent over three decades in the bank by then, of which nearly seven were overseas. Those who know him say the stints abroad had made him an SBI outsider, with an orientation different from his predecessors. As he liked telling colleagues, he wasn’t the first choice as A.K. Purwar’s successor (chairman from November 2002 to June 2006), but had brazenly won over the selection committee with an aggressive vision for the bank.

All of Bhatt’s strategies culminated in one stated objective: Put a huge distance between SBI and ICICI, which would help it stay on top. His strategy was gunning for market share. This, while not unfamiliar or anathema to other banks, was new to SBI. As a former SBI chairman explains, it had its roots in the conservative Scottish banking system and never saw itself as a solely profit-oriented institution.

Though successful, SBI has a strong sense of social relevance. It was the first bank to provide loans to farmers in 1957, and, even today, 12% of its book is loaned to agriculture against the industry average of 6% to 9%. More than a third of its 13,542 branches are located in rural areas where there may be very little business. Ask employees what the real SBI is, and they’ll tell you it’s a bank with a legacy both developmental and commercial. They’ll also admit that a lack of self-belief and indifference has crept into its DNA. A senior consultant who worked with the bank feels Bhatt read that and “used a proselytising or a missionary approach to unlock energy in the bank”.

Insiders remember it differently. “In the first two months, Bhatt ranted that nothing was right,” says a senior executive. In September, he took his top managers for a conclave to a resort town, where he showed them the movie, The Legend of Bagger Vance. The plot, loosely based on the Bhagwad Gita, tells the story of a golfer who loses his swing till a ‘mythical’ caddy helps him rediscover it. In an interview in 2009, Bhatt said, “I tried to draw parallels between the movie, the Gita, the condition of SBI, and the mindset of its officers.” He believed the elephant needed to dance (or, maybe fix its swing).

In his five years, SBI’s loan book grew 189%, the deposit base expanded 146%, it entered the global Fortune 500 rankings in 2006 (No. 498) and, overall, re-asserted its position as India’s largest bank by far. On Bhatt’s last day as chairman (March 31), SBI’s deposit base was four times that of ICICI’s, its loan book three and a half times, and it was valued at
Rs 47,915 crore more.

Bhatt’s push had been almost unreal. An ex-SBI executive reveals that when Tata Steel bought Corus, SBI was the only bank willing to lend it $1 billion (around Rs 4,500 crore). “The entire process, from conception to final sanction, took 48 hours.” Goaded by Bhatt, the team on the deal worked two days round the clock to make it happen.

The 2008 meltdown helped SBI further. “For a while after the Lehman Brothers collapse, we would get as much as
Rs 1,000 crore of deposits every day,” says a senior SBI official. In a single quarter ending December 31, 2008,
Rs 70,000 crore of deposits had shifted to SBI from all other private sector banks. Swimming in capital, Bhatt went after every possible account he could.

He was, by now, the scourge of other banks, the adversary from hell. Says the executive director at a large private bank: “Because SBI’s retail portfolio is spread over so many individuals across so many geographies, they have in-built risk mitigation, and their pricing capability is enormous.” He says around late 2009 SBI “virtually declared a price war on other banks”. It had started picking up accounts from small and medium-sized outfits, rated “avoidable” by other banks, at low rates. Bhatt was also going after companies in sectors others were wary of, such as Kingfisher Airlines, Unitech, and the DLF Group.

Some analysts say Bhatt was overzealous. For example, around August 2008, when liquidity was tight, he kept interest rates around 10% to attract depositors. Post the Lehman crash, even though the RBI slashed rates, Bhatt held on to the high rates until January 2009. As a result, SBI’s net interest margin fell from 3.1% to 2.7% over two years. “Even if he had cut deposit rates to 7%, people would go to SBI. He underestimated its brand,” says one.

The move that defined Bhatt was the New Happy Home loan scheme, started in January 2009. Called ‘teaser loans’ by the RBI, they carried 8% interest in the first year when prevailing rates were around 9%, with stepped-up rates going forward. It was an instant hit with customers and left the competition bruised. By the early part of fiscal 2011, SBI had replaced Housing Development Finance Corp. as the largest seller of home loans. “This was a clear indication that SBI was in pursuit of scale,” says Punit Srivastava, deputy head of equity research at Daiwa Capital Markets.

Bhatt called it SBI’s most creative product ever and defended it against RBI’s increasing anxiety about its risks. In an interview in August 2010, he said, “At a time when India was going through difficult times—growth was stagnating, home loans were not picking up—this product lifted the whole industry. Many people would not have a house but for us.” In his exit interview on March 30, he said “RBI never understood the product”.

NEITHER DID Chaudhuri. On his 14th day of chairmanship, he withdrew the scheme. He also revised growth targets for the current year from 18% to 21% down to 16% to 19%, citing a possible slowing of the economy. “We will not stop growing. We will grow our business prudently and not chase everything that comes our way,” says a senior SBI executive.
Here’s how: Recently, a large company was negotiating with SBI’s Mumbai circle for a $200 million loan. It had an offer of Libor (London Inter-Bank Offer Rate, a benchmark) plus 130 basis points from other banks, while SBI’s terms were Libor plus 200 basis points. “A year earlier, we would have said, ‘We’ll give it to you at 125’. But we told him to go elsewhere,” says the executive. The company finally borrowed $400 million from SBI, at Libor plus 200.

Chaudhuri has also postponed the mergers of five associate banks (State Bank of Bikaner and Jaipur, State Bank of Hyderabad, etc.). In February, in response to a parliamentary panel headed by former finance minister Yashwant Sinha, the finance ministry said that SBI planned to complete the mergers “within a period of 12 to 18 months”. Bhatt, who in his bid for scale was in favour of pushing the mergers, had said that after his discussions with these banks they seemed to be in favour of the mergers. Chaudhuri indicates that mergers will only be discussed next year.

To back his claim on clean-up, Chaudhuri has appointed a deputy managing director, Soundara Kumar (formerly chief general manager, Bangalore circle) to overlook stressed assets. Earlier, the position was filled by a chief general manager, a level lower. “The appointment means that this is a strategic business unit for the bank, with the sole focus being reduction in NPAs,” explains a senior SBI executive. There are also dedicated centres across the 14 regional headquarters to monitor and track the quality of assets and “tighten credit delivery, credit assessment and credit appraisal systems”, says the executive. This means efficient resolutions of existing NPAs and tighter control over new loans.

Thanks to this, the buzz on the street is that SBI’s net interest margin for the first quarter of the current financial year will be healthy. The June quarter target is 3.6% against the FY2012 guidance of 3.5%. In FY2011, it stood at 3.3%.

Chaudhuri is also trying to recast SBI’s culture, among the senior staff for now, what some describe as healing the organisation. Bhatt had a take-no-prisoners style of functioning. “The one thing he exploited to the hilt was whom to promote and whom not to. And in the latter half of his tenure, people were scared of him, not afraid, but scared,” says an ex-SBI banker, who worked closely with Bhatt. He tells the story of a woman who was promoted out of turn to general manager in public relations. “A story that should not have appeared, did. That very evening she was put on inspection duty, which requires one to be constantly on the road. There are scores of such incidents,” he says. Even Chaudhuri, who headed the Chennai circle while Bhatt was chairman, was reportedly denied a promotion for two years. There have also been allegations that Bhatt sparred with the regulator on reappointments of some deputy managing directors.

Chaudhuri’s approach is more collaborative. “While he has a mind of his own, he hears what everyone has to say and always has a logical explanation for his decisions,” says an executive. Chaudhuri is also trying to decentralise power by doubling the number of managing directors from two to four and bringing back the position of deputy general manager, which Bhatt abolished.

This does not mean the bank is in trouble. Of Rs 9.3 lakh crore of deposits at the bank, a staggering 49% are low cost (current and savings account), giving the bank a huge pricing advantage. The one-time hit due to the Rs 7,927 crore pension liability for FY11, which made the bank dip into its reserves, brought down its capital adequacy to 11.98%, but is still far above the 8% mandated by the Basel III norms and 9% by RBI. SBI has done well in containing bad assets, despite gross NPAs of Rs 25,326 crore, on a loan book that stretches to Rs 7.5 lakh crore. It earns the bank a net interest income of Rs 32,526 crore, despite a heavy exposure to the agricultural and the small and medium enterprise sector. In fact, in the first quarter of FY12, the bank emerged as the highest advance tax payer in Mumbai at Rs 1,100 crore, more than Oil & Natural Gas Commission’s Rs 1,062 crore, placing it squarely among the more robust public sector institutions.

So why change tack?

FOR ALL ITS SIZE, reach and influence, SBI is a strange animal. An independent director says that in all the years he’s been on the board, never once has strategy been discussed. “Operational issues get talked about, results are tabled, committees are formed, but where SBI should be, its strategic direction, never,” he says. His insight—SBI’s course is driven entirely by its chairmen’s thinking. “It’s an individual’s vision rather than a collective agenda.”

Then there is the fact that many SBI bosses don’t have terms long enough to make the changes they want. Bhatt was a rare chairman to have a five-year run; most have far shorter terms. Chaudhuri, for example, is due to retire in December 2013. “Even if Pratip has a plan, what can he do in two and a half years?” asks a senior colleague. In comparison, Narayanan Vaghul ran ICICI for 11 years; K.V. Kamath’s term was for 13 years as is Chanda Kochhar’s.

It also doesn’t help that the bank is regulated by two bodies: the Ministry of Finance (owner) and the RBI (regulator). “With the finance secretary, RBI’s representative, and the SBI chairman on the bank's board, there’s no room for another voice,” says the independent director.

Unlike with ministries such as oil and gas or steel, which take hands-on interest in their charges, here the ministry’s position is tight. “The finance ministry cannot do anything legally or formally if it disagrees with the bank management. SBI is governed by a statute. Actually the RBI has more influence as the regulator,” explains the former SBI chairman.

RBI, for its part, is more concerned with processes and norms being followed than strategy. And sometimes the relationship is far from smooth. The tenure of Shyamala Gopinath, RBI’s nominee, was fraught with tension between her and Bhatt, primarily over the teaser loans. Gopinath retired last month and RBI sources said she had been asking to increase the provision coverage since 2006, but it was never done. She was almost singled out where teaser loans and provisions were concerned, they added. Others question the very merit of having a regulator on the bank’s board.

The result is that there’s no cohesive approach for SBI. So, while Bhatt chose not to create a provision for NPAs, knowing such a step would affect the bottom line, within days of his leaving, his successor did. Some other chairman could well do something else.

Yet, everyone that Fortune India spoke to say that India, in keeping with its growing economic size, needs to create giant banks as China has done, and SBI is the best candidate. A former SBI chairman says SBI has the potential to become one of the world’s top 10 banks (Chaudhuri aims to be in the top 50) and that the team leading the bank at the moment is one of the best. “But they need a vision and road map.”

Others like Pradip Shah, founder of IndAsia Fund Advisors, and ex-MD, Crisil, says banking is all about intermediation. “SBI needs to reduce its intermediation costs by controlling components of interest costs, spreading loan losses, and streamlining its operations in terms of delivery.”

BHATT’S LEGACY HAS divided the bank. He has his fans. A few of SBI’s younger employees feel he’d made them all proud. Quite a few of his competitors feel SBI needed some shaking up. But then there are others like a senior SBI director who worked closely with Bhatt and refers to a Harvard Business Review piece on CEOs while describing him. “The article says that CEOs are like toddlers; they find creative ways of solving problems, but when they leave, they leave the room in a mess. Bhatt is like that. And now the mother (Chaudhuri) has to clean up after him.”

That’s harsh. Bhatt’s tragedy was his ideas were right but he carried the notion of change to an extreme and he tried to do too much too soon. And in some ways he has made Chaudhuri’s task difficult, having shown what SBI can be made to do. Chaudhuri will now have to discover the golden mean between aggression and moderation, while keeping both the RBI and the finance ministry happy.

In The Legend of Bagger Vance, the caddy was right when he told the golfer to shed emotional baggage and play his game, because, that was his job, or, to quote the Gita, his dharma. However, the golfer there was a challenger and had nothing to lose. SBI’s position is more nuanced. At one level, it is the establishment and has everything to lose if things go wrong. But, if it doesn’t change, it could lose just as much. And interpreting that astutely will make all the difference for Chaudhuri. And SBI.