Worth banking on new players

After more than a decade, the RBI is set to permit more domestic private sector players to set up banks in India. There are some important markers this time round: corporate and industrial houses, entities in the public sector and NBFCs have been allowed to apply.

The minimum paid-up capital is set at Rs 5 billion with foreign shareholding in the new bank capped at 49 per cent for the first five years, going up thereafter to the current cap of 74 per cent applicable to existing banks.

Private players aspiring to enter the banking space can promote a bank only through a Non-Operative Financial Holding Company (NOFHC), which will also hold all other financial entities of the promoters, thus giving greater oversight to the banking regulator.

The minimum capital adequacy ratio has initially been set at 13 per cent of its risk weighted assets; all prudential norms will be applicable to the bank; there have to be a majority of independent directors on the board; from inception, the bank will be bound by existing priority sector targets applicable to domestic banks and has to open at least 25 per cent of its branches in unbanked rural centres (population up to 9,999). Successful promoters will have to start operations within 18 months.

All about timing

This does appear to be the right time to open up the sector further. Latest reports indicate that 26 entities, including corporate houses, NBFCs, public sector players, microfinance companies and the postal department have applied for bank licences before the RBI’s July 1 deadline.

While all aspirants are unlikely to get an entry into the banking sector, a larger number of banks will mean more competition leading to more products and better service, and therefore a better deal for customers.

It could also lead to consolidation with weaker players merging or focusing only on niche areas. Bigger banks will provide the financial muscle to finance large projects.

But the biggest impact would be on extending reach. Expanding financial inclusion requires not merely opening branches and dispensing credit, but actually expanding access to a range of financial services, such as savings and insurance products, payments services, etc., at low cost.

In this sense, the new norms seek to ensure that not merely are there more banks, but they are also present in remote rural areas which need banking services. Importantly, financial inclusion is not seen as focusing only on rural poverty but also includes the urban poor.

One important issue has been the stipulation of exposure norms, which seeks to address the issue of concentration and conflict of interest.

Checks and balances

The RBI has stipulated that the NOFHC and the bank will not have any exposure to the promoter group and no investment by the bank will be allowed in the equity/debt capital instruments of any financial entities held by the NOFHC.

In this context, the lessons learnt from history must not be forgotten. As pointed out by D.N. Ghosh ( Banking Policy in India , Allied Publishers, 1979), the pre-nationalisation phase dominated by private sector banks was marked by concentration in credit.

In March 1968, 19 per cent of the borrowers claimed 96 per cent of the total credit and as smaller banks declined in number, there was a shift in the composition of advances as the share of loans to big industry rose, while that of agriculture and personal loans declined ( see table ).

In the 60s, bank credit was increasingly diverted to large centres: centres with population of 10 lakh and above accounted for 43 per cent of total deposits but as much as 60 per cent of bank credit with 86.3 per cent of incremental credit during 1961-1966 going to these centres.

Second, the stipulation of rural presence and priority sector norms will help credit dispersal and financial inclusion. To give a push to financial inclusion, the RBI has asked banks to increase lending to micro enterprises in stages from 50 per cent in 2010-11, 55 per cent in 2011-12 to 60 per cent in 2012-13.

This time around, banks will have to achieve 10 per cent annual growth in number of micro enterprise accounts and 20 per cent year on year growth in credit along with no frills accounts, banking correspondents, business facilitators, mobile banking and a business strategy that requires a roadmap that outlines their financial inclusion plans. Third, more regulatory and supervisory powers for the RBI while liberalising is another step in the right direction. The 60s was marked by a period of consolidation through mergers and amalgamations.

The RBI sought to strengthen the banking system by weeding out unsound banks. Banks which could not improve their financial position and methods of operations even after repeated advice and guidance were closed down through refusal of licence.

After the failure of Palai Central Bank and Laxmi Bank in 1960, the RBI acquired the power to frame schemes for their compulsory amalgamation or reconstitution from September 1960.

Following the spate of mergers and amalgamations, the number of commercial banks operating in the country came down from 640 in 1947 to 605 in 1950 and further to 292 by 1961 and 85 by 1969 (Banking Commission 1972).

This time around, liberalising the banking sector is proposed through entry of private banks along with power to supersede boards. Importantly, both times, change was preceded by increase in regulatory and supervisory powers and maintenance of certain minimum standards.

The decision to allow more private sector players is in line with the RBI’s continued efforts to push reforms.

In the banking space, measures include deregulation of interest rate on savings bank deposits, introduction of base rate, guidelines on compensation practices, Basel III capital adequacy norms, supervision of financial conglomerates, limits on transactions and exposures between bank and other group entities, convergence of Indian accounting standards with International Financial Reporting Standards (IFRS), consumer protection, anti-money laundering and KYC norms.

However, going forward, we need a system for exit also and not merely entry of banks because, as pointed out by the Raghuram Rajan Committee (2008), the Indian banking sector is fragmented and there are too many small, uncompetitive players in the system.

Consolidation with emergence of 3-4 international banks, some national banks and others as regional banks will remove overlap and strengthen the Indian banking landscape.

It may also be time to consider reduction in government equity in banks. At present, many public sector banks are limited by the constraints on management and capital and regulations that inhibit flexibility and innovation in banks.

Reduction in government stake will create a level playing field, help banks expand their balance sheet and grow in tandem with the Indian economy, while at the same time bridging the fiscal deficit gap.

In step with the new tech-savvy, nimble-footed players in the private sector, public sector banks will also have to address the issue of skill gaps in IT, risk management, product innovation and also credit assessment along with filling the gaps in personal policy that includes recruitment at market salaries, reskilling and redeployment.

The author is an independent consulting economist and former chief economist, SBI.

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