New banks may not achieve the stated objective of financial inclusion. The dilution in norms is cause for concern.
The Reserve Bank on February 22, came out with its guidelines for licensing of new banks in the private sector. The genesis of allowing new banks can be traced back to the Budget Speech of 2010-11, where the Finance Minister expressed interest in expanding the reach of banking in the rural areas by introducing new private players.
In keeping with the Finance Minister’s announcement, the RBI came out with a discussion paper on ‘Entry of New Banks in the Private Sector’ on August 11, 2010. Based on the comments received on the discussion paper, draft guidelines for licensing of new banks in the private sector were released on August 29, 2011. The final guidelines have been released after almost one and half years by taking into cognisance the feedback to the draft guidelines from different stakeholders.
The final guidelines of 2013 allow corporates, both in private and public sectors as well as NBFCs, to enter the banking space. The draft guidelines issued in 2011, however, had barred entities that generate 10 per cent or more of their income or assets from real estate construction and/or broking activities individually, or taken together in the last three years. RBI’s difference of opinion with the government in allowing real estate/brokerage entities to run banking has been partly responsible for the delay.
RBI in the post reform period had allowed entry of 12 banks in two bouts. First, 10 banks were licensed based on the guidelines issued in 1993 and another two banks as per the revised guidelines of 2001. Yes Bank was the latest amongst banks to have been given license. The motivation for allowing new banks in the 1990s was to improve efficiency by promoting adoption of modern technology in Indian banking. In fact, one of the criteria for granting licenses in the 1990s was that all the operations of the new bank should be on a technology platform.
This specific condition had the desired demonstration effect on the nationalised banks to adopt technology, so as to retain market share. This time around, the stated objective is to promote financial inclusion. The draft guidelines mandated the new banks to open at least 25 per cent of their branches to unbanked rural centres with less than 10,000 population. The final guidelines have retained that clause, though one would have expected this norm will be made a bit tougher.
This is primarily so because the purpose of granting licenses was financial inclusion, rather than increasing competition in the banking space.
Changes in Guidelines
How do the new guidelines of 2013 fare compared to the guidelines of 1993 and 2001? As per the 2013 guidelines, promoters will be permitted to set up banks only through a wholly owned non-operative financial holding company (NOHFC).
In the previous guidelines of 1993 and 2001, new banks were formed as public limited companies. The idea behind NOFHC is to ring-fence the operations of the bank from commercial and industrial activities of the group that are not regulated by financial sector regulators, and also from other regulated financial activities of the group.
In an attempt to balance the twin objective of ensuring promoter’s commitment to the new bank in the initial stages at one end and avoid control by the promoters at the other, the 2013 guidelines require that promoters through a holding company must hold 40 per cent share in the bank for five years. Further, the promoter’s stake must be reduced to 20 per cent in 10 years, 15 per cent in 12 years.
The 2001 guidelines required promoters to maintain 40 per cent stake in the bank for at least five years. In contrast, the guidelines issued in 1993 did not mention any cap on promoters’ holdings in the bank. Further, while the 1993 guidelines did not mention any cap on foreign shareholding in the bank, the 2001 guidelines allowed non-residents to hold up to 40 per cent share in the bank. Foreign banks acting as co-promoters were allowed 20 per cent stake within the 40 per cent ceiling. The present guidelines have capped the non-resident shareholding at 49 per cent for five years.
Though in principle the Reserve Bank does not discriminate against any category of business house, it has incorporated stringent pre-conditions which will ensure that the actual licences are issued to only deserving entities and the scope of connected lending is minimised.
Notwithstanding the pre-conditions, many observers feel the issue of connected lending cannot be effectively checked, especially when bank promoted by an industrial house extends preferential treatment to its suppliers who in turn can give extended suppliers’ credit to the business house in question.
In order to ensure that the promoters of the new banks are ‘fit and proper’, a successful track record of running their business for ten years and sound credentials is specified. In addition, RBI has reserved the right to seek feedback on the promoters from other regulators and enforcement and investigative agencies like Income Tax, CBI, and the Enforcement Directorate.
The minimum capital requirement has been progressively increased from Rs. 100 crore in 1993 to Rs. 200 crore in 2011 and now to Rs. 500 crore in 2013. The new banks are mandated to have a capital adequacy norm of 13 per cent for the first three years compared with 8 per cent from the very beginning in 1993 and 10 per cent on an ongoing basis in 2001.
While sharing his views at Bancon-2012, the Finance Minister expressed that some consolidation in the banking space is inevitable. The idea is to have 2-3 world size banks. Allowing new banks to come up when one is thinking of consolidation makes limited sense, as the new banks to begin with will be relatively smaller in size.
The thinking on financial inclusion also needs to be discussed more clearly as the Bakshi Committee last month has recommended delayering the village level Primary Agricultural credit societies (PACS). India has around one lakh PACS, which are potential vehicles for financial inclusion. Creating new banks at one end and de-layering PACS at the other does not seem to promote the cause of financial inclusion.
The commercial banking space in urban areas is already quite crowded. The addition of a few more banks to this space is not going to significantly improve efficiency of the system. If any, promoting banking in rural areas is the guiding factor for creating new banks. In this context, a critical question that remains unanswered is to what extent the new banks with a mandate to open only a quarter of their branches in rural unbanked centres are going to serve the purpose of financial inclusion.
The author is Professor in Economics and Associate Dean, Xavier Institute of Management, Bhubaneswar. Views are personal