Most of the commercial banks were in the private sector in India till 1969, when a large segment of 14 commercial banks and later in 1980 another six banks were nationalised. The objective of nationalisation was to align the flow of credit with Plan priorities. In the 1980s, a plethora of guidelines for directed lending and regulated interest rates was in place, and the success of nationalisation was felt in terms of outreach of the banking system to remote parts of the country.

Over the next two decades, public sector banks expanded their branch network considerably and catered to the socio-economic needs of large masses of the population, especially the weaker sections and those in the rural areas.

But, since the onset of reforms in early 1990s, with abolition of industrial licensing, directed credit had lost much of its original relevance, though priority lending targets for banks are still in place.

PRIVATE PERFORMANCE

The regulation of interest rates has largely been dismantled and banks are expected to function under a free-market-based environment, managing credit, interest rate and investment risks within the prudential framework of the central bank.

These prudential norms have evolved since the 1990s in consonance with international best practices. In the current environment, with the exception of restrictions to entry, all groups of commercial banks by and large function under a homogeneous regulatory and supervisory environment.

After the nationalisation of major commercial banks in 1969, for well over two decades no new banks were allowed to be set up in the private sector. In the early 1990s, guidelines for licensing of new banks in the private sector were issued in January 1993 and subsequently revised in January 2001.The objective was to instil greater competition in the banking system to increase productivity and efficiency.

Only 12 banks were allowed under these guidelines. Large industrial houses were not permitted to promote new banks.

There are 27 public sector banks and 22 private sector banks operating currently, of which only seven are new private sector banks. The overall performance of private sector banks since 1990 has not been unsatisfactory. The share of private sector banks in total deposits increased from 4 per cent in 1990 to 18 per cent in 2010 and the share of credit increased by the same order, though their share in total number of offices increased to only 12 per cent from 7 per cent during the same period.

While the share of priority sector lending to total adjusted net bank credit showed hardly any increase and remained flat at around 42 per cent for public sector banks, the share of private sector banks increased from 37 per cent to 46 per cent.

In terms of financial services and advancement in information technology application, private sector banks are not behind their counterparts, which is well-acknowledged. If industrial houses are allowed entry, despite all restrictions placed on their operations, they are bound to pose formidable competition to both public sector banks and the existing private sector banks.

Rationale for Expansion

The basic rationale for enlarging the size of the banking system has yet not changed over the last two decades.

Yet, the pressure now is being felt to expand the banking system, for two reasons. First, public sector banks have limited scope to enhance capital within the constraint of government ownership and the government's limitation in expanding its equity base for fiscal reasons.

Second, public sector banks have yet to realise the objective of financial inclusion, and hence a further geographical and regional diversification of banking system is perceived as a compelling need, if the policy goal of inclusive but higher economic growth has to be reached.

The guidelines for allowing new private sector banks were revisited only after the Finance Minister's announcement in the Budget for the year 2010-11. Since then, the RBI has been through a series of consultations after issuing a discussion paper in August 2010 and finally has come out with a set of draft guidelines by the end of August 2011.

The present guidelines prima facie are more complex compared with the earlier guidelines. The complexity has perhaps arisen in the context of allowing industrial houses entry, or rather re-entry, into the banking sector, the perceived inadequacy of the existing legal framework to handle large and complex institutions, and possibilities of regulatory arbitrage.

Cautious approach

The RBI does not want anything to be left to chance, and it is not going to consider fresh applications till the amendments to Banking Regulation Act fully empowering it to handle the new environment are in place.

A cautious approach seems to have been adopted in allowing entry to industrial houses and even non-banking financial companies. Given the recent experience of financial turmoil, the hesitation in allowing entities engaged in real estate and broking activities beyond a threshold level is understandable, even with the arms-length relationship between the banking operations and other operations of a group.

Given the curbs placed on new entrants, not more than a few applications are likely to be considered for new licenses. But it will open a new chapter in Indian banking after 40 years of bank nationalisation in India.

(The author is Director, EPW Research Foundation. The views are personal. >blfeedback@thehindu.co.in )

comment COMMENT NOW