Make the new banks go rural

The Reserve Bank (RBI), on August 29, came out with draft guidelines for issuing new banking licenses in the private sector. The guidelines cover a number of issues, including promoter eligibility, corporate structure, capital requirement, foreign shareholding and the business model for entities keen to enter the banking sector. It has also laid down additional conditions in respect of corporates or business houses intending to enter the banking space.

Why the additional conditions for corporate houses? The RBI is concerned about the possibility of corporate houses indulging in self-dealing — where the bank promoted by a corporate house gives preferential treatment to the promoter over other customers. The additional conditions broadly comprise safeguards to prevent connected lending and self-dealing. Given RBI's genuine concerns, it would only be appropriate to examine the broader issue of allowing corporates into the banking arena.

What prompted the RBI and government to consider issuing banking licences to the private sector? The idea was first mooted in the Finance Minister's 2010-11 Budget Speech, which said that the objective was to expand the geographical coverage of banks and access to banking services. Similarly, RBI in its discussion paper on ‘Entry of New Banks in the Private Sector', has emphasised promotion of financial inclusion as the objective for granting new licences.

EARLIER EXPERIENCE

India's industrial houses have in the past run banks, or worked in close association with banks. In 1951, when India embarked on the process of planned development, there were 566 private commercial banks, many of which had their origins in industrial houses.

These banks, however, concentrated their operations in urban areas and largely catered to the upper sections of the society. In addition, the business models of many private banks were not sustainable, resulting in bank failures. On an average, 40 banks failed in India each year between 1947 and 1955. Liquidation and amalgamation of the private banks to protect the depositors' interest brought down their numbers.

By 1967, the number of banks had declined to 91 with 6,982 branches. Further, to align banking activities with planned development and promote inclusive banking, some of the bigger private banks were nationalised in two phases in 1969 and 1980. Thus, the number of private banks has significantly reduced over time. As on March 2011, there are 14 old private banks operating in the country.

BRANCH EXPANSION

Post nationalisation, branch expansion of public sector banks got a boost. The share of rural and semi urban branches in the total branch network improved from 63 per cent in 1969 to 78 per cent in 1985. However, in the next two decades (1985-2005), the process of branch expansion slowed down considerably. Further, the proportion of rural and semi-urban branches declined gradually from 79 per cent in 1985 to 69 per cent in 2005.

Financial inclusion formed an important plank of the inclusive growth theme of the Eleventh Five Year Plan. There has been renewed interest in branch expansion. The challenge of financial inclusion is formidable, as there are around six lakh villages and only 85,393 branches of commercial banks.

Apart from institutional innovations like business correspondents (BCs) and business facilitators to expand banking services, banks have been asked to cover 72,800 villages with a population above 2,000 by March 2012 through the branch mode. The grant of licences to industrial houses should involve a commitment on financial inclusion. All SCBs were advised by the RBI on July 15 to allocate 25 per cent of the new branches in a particular year to unbanked rural areas. The draft guidelines mandate that new banks open 25 per cent of their branches in unbanked areas. However, industrial houses keen to enter banking should be asked to commit at least half their branches in rural and semi-urban areas till the goal of reasonable financial inclusion is met.

If industrial houses indeed have the capability to innovate business models, it should not be difficult for them to develop banking models for rural conditions.

Some may argue that one should not be rigid on financial inclusion as an overriding criterion for granting licence, as there are other benefits of industrial houses entering the banking space — such as furthering competition and efficiency. However, the introduction of new private banks in the mid-1990s and liberal entry norms for foreign banks have already served the cause of promoting competition.

OTHER ISSUES

Given the financial muscle of industrial houses, meeting the capital requirement of Rs. 500 crore is least likely to be an issue. Apart from the commitment to financial inclusion, the issue of inter-connected lending, possibility of money laundering activities and appropriate supervisory mechanism needs serious consideration before granting banking licenses to industrial houses.

The draft guidelines have attempted to address many of these issues. Industrial houses need not be denied the opportunity to enter the sector, but maximum care should be taken to ensure that they play the game according to the rules.

The RBI has taken over a year to release the draft guidelines after publishing the discussion paper. This suggests that it is tentative, and wants to go slow in issuing new bank licences.

The conditions governing grant of licence should have an explicit commitment to open a relatively larger share of branches in the rural and semi-urban areas.

(The author is Chief Economist, Bank of India. The views are personal. blfeedback@thehindu.co.in )

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