Determinants of Growth Indian Banking Industry & Auto Industry

This paper analyses various factors that contribute to the growth of any industry and to find out the most important factors among them. The regression model technique is used for over 17 companies of Bankex and 23 companies of BSE Auto Index for the period 1999-2000 to 2004-2005. The primary reason for focusing our study on these two industries is the fact that they plays an important role in the economic development of a country by way of providing services and contributing to the manufacturing sector respectively. The paper finds retention ratio, debt-equity ratio are the major factors contributing to the growth of both the industries under study.

Growth is the fulcrum of any valuation.There are several approaches used to obtain the growth rates for an entity.It can be derived from the past growth of the company, or the estimates can be based on the inferences of an analyst who has beeafollowing the company for at least some time, or the estimation can be based on the fiindamentals of the company.In today's competitive world when the world is getting smaller day by day.Companies are following the path of both organic growth and inorganic growth.Companies very often go for acquisition of other companies working in the same market to grow in size and increase its profits.Here arises the need for estimation of the future growth rates which is dependent on future cash flows.Any expert doing valuation of such a company definitely has to look for some determinants of growth.

Sharma, Chaturvedi
There are several factors determining the growth prospects of a company Hke Return on Equity, Retention Ratio, Debt Equity ratio, Interest rate.Tax rate and Beta etc.These factors have always been important for any industry's growth estimation.This research has been done to find the relevance of these factors for the growth of the BSE Bankex and BSE Auto Index companies.BSE Bankex comprises of 17 private and public national banks whereas BSE Auto Index has companies manufacturing auto parts and all types of vehicles.Both these sectors do have their own business dynamics but the measurement of growth can be done by analysing the above factors which have been recognized world over as the determinants of growth.

THEORETICAL FRAMEWORK OF RESEARCH
Growth can be determined by various means such as by past growth rates, or by the views of an active analyst, or through the fundamentals of a company but the basis for all these estimations are the product portfolio of the company, margins of profit, degree of leverage, and the dividend policy followed by the particular company.
Return on Equity (ROE) and Retention Ratio (percentage of earnings retained in the company) can provide the simplest and the most accurate measurement of growth.The relationship is as follows- In the above relationship Retention Ratio and ROE are having a direct relation with growth.Thus, growth is an increasing function of both the Retention Ratio and ROE.

THE REGRESSION MODEL FOR THE RESEARCH
There are two methods of calculating growth -arithmetic mean and geometric mean.Arithmetic mean weighs percentage change in growth equally and ignores compounding effect.On the other hand, the geometric mean considers compounding but deals with only first and last observations in the series so some pattern in the growth in that period could be missed out.
To overcome this problem an average of growth and other factors for the period under study has been used.There are two versions of regression that are linear and log linear.Linear regression gives the unit change in the dependent variable for one unit change in any of the independent variables and log linear regression gives the percentage change in dependent variable for one unit change in any of the independent variable.Linear regression has been followed so as to overcome the problem of using arithmetic mean or geometric mean, at least to some extent.
We have used the multi factor regression model for one study.There are six independent factors taken with one dependent variable.These factors are- Our study, to determine the factors affecting growth, is based on the relationship between retention ratio and ROE.The simplest form of this relationship is-

g, =bxROE
Here ROE can also be written as Above formulation shows a direct relationship of ROE with D/E and ROA and indirect relationship with post tax interest rate.This formulation indicates that if the pre interest, after tax return on assets (ROA) exceeds after tax interest rate paid on debt than ROE will be positively increased.So growth can be written as Asset Turnover Ratio or vice versa but this will depend upon the demand and supply relations prevailing in the market.So, the lower price of the product can result in lower profit margins but higher turnover, if the quantity sold is so high that it to increases the revenue from the earlier levels.

Post Tax Interest Rate
Post Tax Interest Rate^ = Interest Payments (1-t)/ Average Borrowings where Post Tax Interest Ratet is interest in time period t Interest rates depend on the amount of debt held by the company, its size and time in the maricet.Small and growing companies generally pay higher interest rate as they are having higher risk of default due to higher growth.As time progresses and the size of the company increases the interest rate goes down and the pay back period increases.
Borrowings have an inverse relationship with interest rate.As the company grows in size, it is able to finance its projects from its reserves and retained earnings.So, the size of debt decreases and in turn the interest rate also, falls.
Tax paid is directly related to the Profit Before Tax (Tax Rate=Tax Provision/ PBT).So, with the increase in profits the tax payment also increases and the Post Tax Interest Payments decrease as Post Tax Interest Rate goes down.

Retention Ratio
Retention Ratio (b^) = Retained Eamings/PAT where-b^ is the retention ratio for t time period Retention Ratio is related to financial restructuring decisions of the company.Amount of retained earnings depends upon the capital requirement of the company for fixture projects and its decision to finance them.If a company has a project on the anvil then the dividend paid to the investors could be low.Thus, this ratio also, has an indirect effect on the D/E ratio.If a company goes for high Dividend payments (low Retention Ratio) then for financing the new projects it has to take debt(if it doesn't use reserves or they are insufficient) which will increase the D/E ratio and in turn can affect ROE positively(also depends on ROA and interest rate).

Sharma, Chaturvedi
Thus, a higher Retention Ratio can lead to higher growth for the company but the effect will be affected by the change in the other factors also.

Leverage (D/E Ratio)
Leverage has a direct impact on the growth of the company.With higher D/ E ratio a firm can grow faster if ROA is more than the Post Tax Interest Rate.D/ E ratio signifies the capital structuring decision of the firm.

g,=b{ROA + %[ROA-i{l-t)]]
Capital stmcturing determines the amount of risk with which the firm is faced.Changing the asset mix leads to a change in the risk level of the firm.
D/E ratio is also affected by the retention ratio.A higher Retention Ratio can lead to a Higher D/E ratio when company has to finance the new projects by debt because of inadequate reserves or low cost of debt financing.All the small companies start with debt financing and with the passage of time they go for equity financing.So in the initial years the D/E ratio is higher than the later years.

Beta
Beta signifies how much the company is prone to market changes or how much will be the change in the company's earnings with one unit change in the market earnings.It shows the market specific return for a company.
Companies in high growth phase and small in size generally have higher beta.As the company grows in size the market dependency takes a more mature form.This is the reason why small companies generally outperform the big companies in terms of returns (at least in short term).Also the credit-worthiness of companies increases with the growth which will decrease the beta.

Data used for the study
This research has been conducted for the BSE Bankex and BSE Auto Index.The data is taken fi-om PROWESS (Centre For Monitoring Indian Economy) database.The data has been taken for the period 2000-2001.For calculating the growth of2000 the Profit after tax (PAT) of 1999 has been also used.

Allahabad Bank Indusind
Andhra Bank Karnataka Bank Ltd.

Study of the Auto Industry
The data was taken for the period of2001 -2005.For calculating the growth for 2001 the PAT of2000 has been also used.

Formulae used in the study
The variable for representing growth is taken as growth in PAT over the years.The determinants of growth are taken as-

•
The banks belonging to B SE Bankex have seen a significant increase in their growth over the period of study.The pre interest after tax margins have been more or less stagnant during the period of study.Banks have witnessed high turnover ratios.For few banks it is 6 -7 times and on an average maintained at 2 -3 times.
• Retention ratio is very high ranging between 60 %-100 % which corroborates our earlier finding that companies are growing at an increasing rate.Also, D/E ratio is increasing which may be because banks have greater confidence in the easily available capital raised from other banks or RBI.Post Tax Interest Rate has been increasing which also indicates the higher debt portion in the balance sheets of the banks.

BSE Auto Index
• Auto and auto parts manufacturing companies have achieved a bigger size in recent years but the growth of the companies has been volatile.Companies are having higher tumover ratio which shows efficient utilization of the  and 5.89 respectively.Thus, the value of growth will be increased by 5.26 times with 1 unit increase in Pre Int.After tax Margin and by 5.89 times with 1 unit increase in Post Tax Interest Rate.Retention ratio is also, having significant direct relationship with growth as every unit change in retention ratio will increase growth by 0.86 units.

CONCLUSION
The objective of the research was to determine the factors contributing to growth of BSE Bankex Index and BSE Auto Index.In the start there were six factors taken as proxy of growth.These factors were Pre Interest After Tax Margin, Tum Over Ratio, Retention Ratio, D/E ratio, Post Tax Interest Rate and Beta.PAT growth was taken as the proxy for growth.However, in the regression analysis it was found that only Retention Ratio and D/E Ratio are the determinants of growth of BSE Bankex companies.Apart fit>m the above two factors two more factors were found significant for the growth of BSE Auto Industry Pre Interest After Tax Margin & Post Tax Interest Rate.
increasing ftinction of both the Pre Interest After Tax Margin And Asset Turnover Ratio.There is a trade oflFbetween these two components.It has been found that an increase in Pre hiterest After Tax Margin will decrease Management Dynamics, Volume 6, Number 2(2006)

BSE
Bankex is the benchmark Index for the Banking Sector which comprises of 17 Nationalized Banks.Some of the banks from this index are-Allahabad Management Dynamics, Volume 6, Number 2(2006) Bank, Bank of Baroda, Canara Bank, HDFC Bank, ICICI Bank, Punjab National Bank and State bank of India etc.
for the companies has been taken from the PROWESS database.