India's macroeconomic potential is staggering.

By some estimates India's growth domestic product stood at $1.25 trillion (at the official exchange rate) in 2008. The CIA ranked the country's purchasing power-parity GDP as fifth-largest in the world last year, and there are estimates that its middle-class population could explode to half a billion in less than two decades.

But where India doesn't seem to impress is in its bank sector. The country is served by only 25 public-sector banks, 21 domestic private-sector banks, and less than 20 Western private institutions. Of the latter, just five banks - HSBC, Citigroup, Standard Chartered Bank, ABN Amro, and Deutsche Bank - have established retail operations primarily aimed at native customers in a population of more than 1.66 billion.

India, and its people, represent an opportunity that more Western banks should be looking at, say observers. India's becoming more than just being a place to set up low-cost call centers and processing operations.

"India is a very, very under-banked nation for the size of its economy," says Arun Kumar, principal in charge of KPMG's US-India practice. Public-sector banks control about 50 percent of the total banking business, and 75 percent of the country's deposit base.

There is tremendous pent-up demand for savings products, home mortgages, auto loans, personal loans, insurance, bonds, and equities by a rapidly expanding middle class, Kumar says. On the commercial side, there's a growing appetite for small business loans and infrastructure project financing.

Despite a reputation for grinding bureaucracy, the government has a relatively benign relationship with private-sector bankers.

"There are some limits in ownership, but they're not punishing, and the government is liberalizing the rules," Kumar says. Foreign banks generally operate through offices that are 100-percent owned by their parent companies.

Setting up an operation is pretty painless; there are no onerous approvals. Institutional investors can own up to 74 percent of local banks incorporated in India. But individual stakes above 10 percent require approval from the Reserve Bank of India.

Capital ratios and other regulatory rules are no tougher than anywhere else, adds Kumar. And while price competition is fierce, interest rates are higher in India than in the U.S.

Naina Lal Kidwai, group general manager and country head of the HSBC Group in India, vouches for India's vast potential.

HSBC India is one of the top 10 insurers in India, and is a major player in asset management, overseeing $4 billion within India and $8 billion abroad for Indian customers. It has a customer base of 2 million people, but has room to grow: only around 3 percent of Indians carry life insurance policies, and the savings rate is just 35 percent.

"The potential market is enormous," Kidwai says.

While the Indian customer base is already a fertile one for Western banks, the best is yet to come, according to analysts.

The Indian economy has continued to expand, and its banking sector remains resilient in the face of the worst economic downturn since the Great Depression.

Kidwai acknowledges that growth in India's gross domestic product has slowed amid the global breakdown, easing from an average 8.6 percent growth in the past four years to 6.0-6.5 percent now. But growth could top 8 percent in 2010.

India's relatively low level of exports - 21 percent of GDP - has insulated the country from the impact of the global recession. Meanwhile, its state-dominated banking sector and low risk appetite protected India to a large degree from the global financial meltdown. Government-controlled institutions could not own exotic investments, and were spared the damage suffered elsewhere.

Kidwai believes that the government's presence in the domestic banking industry will decline.

"The sector needs to raise money for the next phase of growth. You will see a wave of consolidation in the government-owned sector. Government ownership will dilute as banks raise money through share offers," says Kidwai.

Meanwhile, the universe of banking customers is huge: the Indian workforce exceeds 520 million people today. And there are projections that the country's middle class will swell from 50 million people to 583 million people by 2025; Goldman Sachs says Indian GDP could expand to $28 trillion by 2050, with per capita income increasing from around $1,150 to $17,000 in the same period.

Kidwai believes these estimates are realistic. "India continues to engage globally," she says, "but we have thriving domestic consumer demand and I don't see that trend changing."

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