Banks & New Licensing Policy - Are we heading to “U” turn?

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Banks & New Licensing Policy - Are we heading to “U” turn?

NSN REDDY*

The Indian enterprises made significant entry into banking business in the early twenties and strengthened further during the growing nationalist sentiment and freedom movement in the country. In the process, major banks were concentrated in the hands of few business houses and the resources mobilized by these banks were diverted to favored groups neglecting the vital segments of the economy. In order to channelise the bank funds to the neglected sectors, 14 banks were nationalized in the year 1969 followed by another 6 in the year 1980. The initiatives taken by the government, commercial banks marked a paradigm shift in branch expansion and credit delivery mechanism thereby paved the way to Mass Banking from Class Banking.

Till pre-reform era, the Indian Banking industry was dominated by Public Sector Banks (PSB) and majority of their operations including pricing of products, were governed by the regulator i.e. Reserve Bank of India. During this period, banks were tuned to operate under regulated environment, especially in the areas of lending and pricing of products. In the process, the PSBs have become inactive/reactive entities while customers expected a proactive approach from banks.

In order to instill grater competition in the banking system and to enhance the productivity & efficiency further, RBI adopted a liberalized policy and allowed Private players to enter into banking in the post reforms era. Broadly, the developments can be classified in to three important phases.

First Phase (1993 to 2003) - RBI had granted licenses to ICICI Bank, HDFC Bank, UTI Bank (now Axis Bank), Global Trust Bank, IDBI Bank, Times Bank, Centurion Bank, Bank of Punjab and IndusInd Bank to setup banks in India. Majority of these banks pertain to financial institutions of the country.

Second Phase (2004 to 2010) – Though the performance of the New Generation Private Sector Banks was quite satisfactory, the episode of Global Trust Bank has sent alarming signs to the banking industry. Thus, making the regulator cautious and judicious while allowing licenses to new players and while monitoring the performance of the existing players. In the above backdrop, RBI gave permission only to two banks viz., Kotak Mahindra Bank and Yes Bank.

The entry level capital requirement for new private sector banks as prescribed in 2001 was initially Rs.200 crore with a commitment to increase it to Rs.300 crores within three years. Large industrial houses were not permitted to promote new banks. However, individual companies, directly or indirectly connected with large industrial houses were permitted to own 10% of equity, without any controlling interest.

RBI allowed licenses to 10 New Private sector Banks since 1993 of which 4 were promoted by financial institutions and the remaining 6 by individual banking professionals. Ironically, the banks promoted by individuals either failed or merged with other banks viz., GTB with OBC and Times Bank, Bank of Punjab and Centurion Banks with HDFC Bank.

Third Phase (Beyond 2010) - The Finance Minister has announced in the recent Budget (2010) that the RBI is considering some additional banking licenses to private sector, including Non Banking Finance Companies (NBFCs) with an objective to extend the geographic coverage of and improve access to banking services, to promote financial inclusion.

A host of NBFCs such as Reliance Capital, Aditya Birla Financial Services, Tata Capital, IDFC, M&M Financial Services, L&T Finance, Bajaj Auto Finance, SREI, Magma Finance Corporation, Sundaram Finance, Religare and India Bulls Financial services besides financial institutions such as IFCI, Micro finance companies are believed to be warming up for a foray into the banking sector.

It is evident from the list of aspirants that a majority of NBFCs are backed by large corporate entities showing keen interest in banking since this segment is lucrative and an effective channel to mobilize low cost funds to fund their business interests.

The positive aspect of NBFCs to become Banks – they are complimentary financial institutions to banks, typically focusing on the niches that are undeserved or neglected by the banking channel and in a way promoting financial inclusion. These institutions are ideally placed to float banks as they have developed lending and recovering capabilities in the semi-urban and rural areas over the past few decades.

The flip side of the issue - there are several deep rooted fears in allowing NBFCs, especially backed by Industrial and Business Houses, to own banks. Mainly, these relate to the fact that such an affiliation tends to undermine the independence and neutrality of banks as arbiters of the allocation of credit to the real sectors of the economy. Further, there is likelihood that banks promoted by corporate houses may deny credit facilities to their competitors, against sound banking principles.

Conflict of interest, concentration of economic power, likely political affiliations, potential for regulatory capture, governance and safety net issues are the main concerns. Despite stringent guidelines, considerable bank credit is being siphoned to real estate by the borrowers, which is causing concern to the regulator. Added to this, the aspirants of new banks either have direct exposure to real estate or through group entities which may jeopardize the interest of the financial system and the public at large.

The entry of Private Sector Banks forced the PSBs to pay focused attention on customer service to sustain and grow further in the present competitive environment. However, PSBs are constrained to function in uneven level playing field since they continue to balance both commercial element and social cause. In such a scenario, opening of new banks may lead to further drift in clientele base (high-value) and market share of PSBs.

As per the existing guidelines, new private sector banks are expected to meet priority sector lending target (40 percent of net bank credit) as applicable to domestic banks and further they need to meet the branch expansion criteria i.e. opening of 25 percent of its branches in rural and semi-urban areas to achieve financial inclusion and thereby inclusive growth.

The million dollar question is - how the new banks are going to accomplish the desired branch expansion and inclusive growth when the performance of the existing private sector banks itself is far from satisfactory. Of late, some private banks are contemplating to achieve the task by adopting the strategy of Branchless Banking through Business Correspondent (BC) /Business Facilitator (BF) model.

The business model (BC/BF) contemplated by the existing new generation private sector banks can be easily replicated by PSBs since these banks are equipped with Core Banking, which is a prerequisite for Branchless Banking.

Discussions invited by RBI on the new bank licensing policy with the stake-holders is an indication that the regulator is keen to rollout the process of issuing licensees to new players shortly. However, the issue remains to be seen whether priority will be accorded to NBFCs or Large Industrial Business Houses or Micro Finance Institutions.

In case, the issue of licensees to the entities backed by Large Industrial Business Houses is inevitable, the regulator needs to focus attention on the following important aspects to ensure the stability of financial system and to protect the interest of the public at large.

Ø Industrial Houses with a good track record of at least 10 years in the financial services business should be allowed.

Ø Ensure that the new players start operations with minimum capital of `1000 crores.

Ø Exposure to real estate in terms of assets should not be more than 10% of the total assets of the group.

Ø The ownership and control of the real estate arm should be separated from that of the financial services business.

Ø Dilution of promoter’s stake should not be allowed for the initial 10 years.

The prudent banking practices adopted by Public Sector Banks and the moderate protective measures initiated by the regulator has enabled the Indian Banks to insulate from contagious effects of global financial crisis. In the post global financial crisis, many central banks across the world shifted their focus and are now moving to protective environment by providing government support to the failed/tainted Private Sector Banks for survival and to face the emerging challenges. Surprisingly, India is opening doors to Private Sector in the financial sector!!!

A cautious approach needs to be adopted by the regulator with regard to allowing permission to new entities to set up Banks in India in the light of the recent financial crises across the globe causing tainted assets, regulatory failures and non-compliance of Basel norms.

Let us think for a while and introspect honestly to answer “Whether India needs new banks, if warranted, what models to be adopted? Hope the Indian Banking system continues to be vibrant & strong and ensure that the interest of all the stakeholders will be protected.

***October, 2010***

*[Mr NSN Reddy, who is working as Chief Manager, in Andhra Bank has B,Com, CAIIB, PGDBM (NIBM) qualifications to his credit and has over 32 years of Banking experience]

Important Notice : [The articles written by authors contains only the academic view of the writer and purely for discussions and updation of the knowledge of the bankers. The views expressed in the articles may not at all be subscribed by the organisation where the author is working and / or AllBankingSolutions.com]