A watershed in banking sector reforms

K Srinivasa Rao | Updated on November 24, 2020 Published on November 24, 2020

Vital link Indian economy’s $5-trillion journey hinges on the banking sector’s expansion   -  REUTERS

The RBI panel’s suggestion to open the field to new players will help the economy achieve its growth potential

The RBI Internal Working Group’s proposed measures are well designed with a futuristic mindset to expand the banking network that should help the economy reach its growth potential . Looking to the strategic role of banks in harnessing entrepreneurial potentiality, the present size and activity of banks fall far short of the needs.

The inadequacy has become more glaring in the current crisis when banks have a critical responsibility to bail out distressed entrepreneurs using innovation, regardless of the risks and with some aggression, even. Lacking in capital and with bulging non-performing assets (NPAs), banks do not have the wherewithal to act effectively and reach out in support of the masses.

The policy shift

The IWG’s recommendation to allow large NBFCs owned by corporates/private entrepreneurs with asset size of ₹50,000 crore and above to convert into banks is a well-thought-out move to increase the size of the banking system itself. With at least 10 years as shadow banks, they will have a different approach to credit appraisal; risk-based pricing, monitoring and recovery strategies.

The RBI panel is also open to Payment Banks (PBs) with three years of operational experience converting into Small Finance Banks (SFBs). SFBs and PBs will have to be listed within six years from the date of reaching net worth equivalent to entry requirements prescribed for universal banks – ₹1,000 crore — or 10 years from the date of commencement whichever is earlier. Promoter shareholding is to be raised from 15 per cent to 26 per cent while non-promoter shareholding — voting equity is capped at 15 per cent. It provides a right balance to the stakeholders and makes an entry into banking an attractive value proposition. The minimum entry-level capital for universal banks is now pegged at ₹1,000 crore and ₹300 crore for SFBs. However, there is no change for PBs, for which the capital requirement remains at ₹100 crore.

A non-operative finance holding company (NOFHC) structure to separate ownership and management control is expected to take care of the ‘conflict of interest’ issues. This is in line with the recommendations of the PJ Nayak Committee report reviewing ‘Governance of Boards of Banks in India’, which even called for Public Sector Banks (PSBs) to separate government ownership and grant autonomy in their functioning. The transition of the ownership structure of existing private banks licensed before 2013 is also clearly outlined.

Trends of banking growth

The entry of new generation private banks in the post reform phase and of differentiated banks have added new dimensions to the size of the banking system, but it is still not enough to tap the full potential of the economy.

According to the financial inclusion index of World Bank, over 80 per cent of the people above the age of 15 years have a bank account in India. thanks largely to the launch of the Pradhan Mantri Jan Dhan Yojana (PMJDY) scheme in August 2014.

The direct benefit transfer (DBT) of subsidies and other government relief that increased transactions through the digital mode played a big role in expanding customer connect. But despite this impressive expansion, bank credit to gross domestic product (GDP) ratio is still languishing around 50 per cent compared to 150-200 per cent in advanced economies or even China.

So despite India being the fifth largest economy, only State Bank of India ranks among top 100 global banks. Looking to the size and scale of our economy, we need to have 5-6 banks in the top pecking order. One of the objectives of large scale consolidation in the PSB space is to improve the banking asset size.

Potential prospects

The IWG’s recommendations may address many of these shortcomings. It can lead to the entry of aggresive players providing a wide choice to consumers in terms of products and pricing. By initial indications, nine private sector and five state owned NBFCs may get qualified to set up, or turn into, banks adding to the present strength of 143 banks (June 2020). An organised dissemination of digital and financial literacy will also be essential to connecting with large sections at the bottom of the pyramid. The new entrants should also not be deterred by the pile up of NPAs in the banking system.

Reforms of central bank

With the impending expansion of number of banks and non-banks, the onus of the central bank to oversee the orderliness, sustainability and compliance standards will increase. Fintech companies, peer-to-peer lenders and neo-banks add to the challenges of the supervisory system.

With cooperative banks and housing finance companies already added to the list of regulated entities, the RBI has to plan and reorient its human resources and draw in new talent to oversee the rapidly expanding banking system and, especially track signs of stress and ensure that there is no systemic threat.

The task of expanding the country’s banking system is daunting. The low asset size of the banking system is an obvious weakness that needs to be kept in mind by the stakeholders in articulating future growth strategies. But, in the long run, the new approach to expand banks is crucial to ensure a multidimensional growth to fast foward India to a $5-trillion economy.

The writer author is Adjunct Professor, Institute of Insurance and Risk Management – IIRM, The views expressed are personal

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Published on November 24, 2020
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