Banking business is all about trust. A key lesson from the recent global financial crisis is that each time a bank fails, it erodes faith in the system, which might eventually lead to a systemic collapse. This explains the Reserve Bank of India’s reluctance in handing out licences liberally in the past decade. The RBI has, however, recently released the “Licensing of New Banks in the Private Sector” guidelines, which aim at creating a banking entity which is adequately capitalised, financially inclusive, backed by a competitive business model and has robust corporate governance. This announcement has enthused some banking aspirants, leading to a flurry of activity over the past few weeks as they prepare to apply for licences.

No doubt a banking licence would provide the aspirant an opportunity to identify and capture synergies in the financial services business, reduce cost of funding, increase shareholder value and be a part of an industry which has been growing at nearly 20 per cent over the past decade. However, along with the opportunities come the challenges. While the number of new licences has not been specified, the guidelines demonstrate the regulator’s intention to entertain only a handful of eligible candidates who are willing to make a long-term commitment and contribute meaningfully towards financial inclusion. The RBI has retained a significant amount of discretion and subjectivity not just to grant licences but also determine the governance framework under which these entities will operate.

The guidelines specify several parameters for minimum capital requirement, corporate structure, ownership and governance, foreign shareholding, eligible promoters, specific provisions for NBFCs (non-banking financial companies) converting into banks, business model considerations and so on, some of which could pose significant challenges for potential aspirants. Key highlights of the guidelines include

Eligible promoters are defined as entities/ groups in the private and public sector with sound credentials and integrity, backed by a successful track record of 10 years.

To improve governance and ring-fence the financial services business, new banks shall be set up only through a wholly-owned Non-Operative Financial Holding Company (NOFHC).

Voting equity ownership in NOFHC should be widely held.

The minimum voting equity capital has been pegged at Rs 500 crore, with the promoter NOFHC holding minimum 40 per cent with a five-year lock-in period.

Initial foreign shareholding has been restricted to 49 per cent for the first five years as opposed to 74 per cent permitted under the existing FDI policy.

To improve corporate governance, at minimum 50 per cent of the board should comprise independent directors.

Existing NBFCs can promote a new bank or convert themselves into a bank and have minimum net worth of Rs 500 crore.

NOFHC should follow prudential and exposure norms both on solo and consolidated basis.

The bank shall open at least 25 per cent of its branches in unbanked rural centres.

Applicants have started preparing for the test of responsiveness in terms of governance, structure, capital readiness and a well-articulated economic value-additive business model that is both economically feasible and supports financial inclusion. As there is still some ambiguity among applicants over the guidelines, the RBI requested the various stakeholders to submit their queries by April 10, 2013; these would be answered on its Web site.

In the past, the apex bank’s stated objective for granting new licences was to infuse competition into the banking sector, which was largely dominated by public sector banks. Consequently, new private-sector banks have brought about a paradigm shift by increasing the efficiency of the domestic banking system, and introducing newer and more sophisticated financial services like mobile banking. This time, the buzz word is financial inclusion — the process of providing access to the financial products and services needed by weaker sections and low-income groups at affordable cost in a fair and transparent manner.

Till date, banks saw financial inclusion as an obligation and not business opportunity and, hence, the reach was inadequate. In a country where nearly 40 per cent of the adult population does not have access to banking services, there is a huge untapped opportunity for new players in financial inclusion. The most critical factors that will differentiate one candidate from another will be the business plan and promoter’s reputation, backed by a successful track record. The new entrants will thus need to capture the enormous business opportunities in rural India if they are to be successful in obtaining the much-coveted bank licence in the near future and subsequently build a business which will be profitable, sustainable and boost the general public’s confidence in the Indian banking system.

Kalpesh J. Mehta is Partner, and Neville M. Daruwalla is Manager, Deloitte Haskins & Sells

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