Govt to allow more private banks

A Fortnight ago, the Reserve Bank of India (RBI) issued a discussion paper on what should be rules for issuing licences to set up new banks in the country. Though it is still a discussion paper - and may take long before evolving into a final guideline - yet, many in the banking industry and prospective new entrants are fiercely debating the significance of the issues raised in the RBI paper.
 
“A larger number of banks would foster greater competition, thereby reducing costs, and improve the quality of service.  More importantly, it would promote financial inclusion, and ultimately support inclusive growth,” was the reason cited by the RBI for allowing more banks.

RBI has identified six areas of concern, like minimum capital required to set up a new bank as well as promoter contribution, minimum and maximum caps on shareholding (both promoters and other shareholders), permissible foreign shareholding, the desirability of giving licences to industrial and business houses, allowing NBFCs for conversion into a bank or to promote one and finally, the business model for the new banks. The intent of the ‘discussion paper’ seem to suggest that the apex bank wants to set stiff terms for new bank licences. Having learnt from past mistakes like giving licences to individuals (like Ramesh Gelli) where banks have either collapsed or the promoter made huge pile of money by selling licence in a short period of time, RBI wants to safely keep such ilk out this time.

Pros and cons

At the same time, the discussion paper has evoked mixed reactions.  For instance, National Institute of Public finance and Policy (NIPF) Senior Fellow, Ajay Shah views it as a good paper, “technically” that allows positive discussion on allowing corporate houses into banking, something RBI has been opposed to. “It is a genuine discussion paper that kicks off an interesting discussion,” Shah said.

If one were to look at the architecture of the banking system, the sector is dominated by 27 state-run banks and 22 private-sector banks which include both old private banks and new ones - the last domestic banking licence by RBI was allotted to Yes Bank in May 2004.  Those who oppose entry of new banks think that not enough has been done to enhance the operation of old private banks as most have remained small despite being around for 60-80 years. Such critics feel that new banks may not solve the problem of banking penetration as past experience showed that all new banks have remained urban centric.

However, HDFC Chairman Deepak Parekh views it differently giving a macro perspective when he says: “..it’s always a breath of fresh air to have new people coming into the sector. For one, the un-banked areas in India are very large and there is a huge amount of people who still have no access to banks in rural areas, as such some thrust is needed there.   Also going by the past, Parekh points out, RBI plans may be to give only a limited number of licences. “They (RBI) will probably give more but on an annual basis a couple for two or three years. So, it is not going to disrupt or impact or affect the existing banking operations or banks that are operating.” he adds.

Global experience

In other countries - discussed in the paper - experience of allowing industrial houses to promote banks is varied. The US does not allow, whereas Canada, UK and South Africa do, while South Korea used to allow it until the East Asian financial crisis divulged that chaebol-owned banks had done much business ignoring conflict of interest norms.  In this context, SBI’s former chairman S K Purwar said, “…in India we have some industry houses who carry a lot of trust to the people, who have set up significant financial services business, conducted themselves very well in a highly ethical manner. Some of these industry houses need to be encouraged, (to set up banks)…” To be on the safer side, RBI may issue a very few licences. In this context, Angel Broking’s VP-Research Vaibhav Agrawal said, “Looking at safeguards like diversified shareholding of promoter companies, we expect RBI to dole out only three to four licences, to be handpicked from several contenders.”

Many contenders

Entities like Reliance Capital, Aditya Birla Nuvo, IL&FS, IFCI and Indiabulls to mention a few are reportedly planning to enter the banking space. So are some NBFCs like Bajaj Finserv, Sriram Transport Finance who also look reasonably capitalized to enter this space. “It makes sense for diversified conglomerates or financial services firms (Bajaj Finserv) to get into banking, as it will complete their bouquet of services,” says KPMG Financial Services Head Abizer Diwanji. As an intermediate step, RBI has suggested that industrial houses could acquire Regional Rural Banks (RRBs) before allowing them to set up a bank. But experts, including some bank chiefs, say that it is easier said than done because 50 per cent shareholding of RRBs is with the central government, 35 per cent with the sponsor bank and the remaining 15 per cent with the state governments. To change shareholding rules there is a need to amend RRB Act, 1976, that would obviously take time. Currently, there are 86 RRBs sponsored by 27 government-owned banks. Barring a few, most of them are making losses, though some data suggests that top five RRBs have a business (deposits and advances) volume of over Rs 35,000 crore.

Naturally, corporates and NBFCs interested in new banking licence would rather have their own network of branches with rural focus than pitching for RRBs.

 Strict norms

If and when RBI decides to allow industrial groups to set up banks, they must ensure strong regulatory watch apart from insisting on a diversified shareholding pattern to ensure adequate checks and balances. Above all, a bank promoted by the group should be ‘ring-fenced’ from other group companies.  On the start up capital, every one is veered round to a figure of Rs 500 crore be minimum and mandatory, while some prefer the minimum to be Rs 1,000 crore also. The problem is higher the capital you make, the entry point becomes fewer and narrower, as very few can muster that kind of capital.   On the promoter shareholding issue, most agree to start with 40 per cent minimum to ensure that trust, faith, responsibility and above all, accountability for taking money from the public.  Each country has its own model based on the perception of its own needs, perhaps India can take a closer look at Canada, where the promoter holding declines with the subsequent increase in the share capital.  On the foreign investment in new banks, RBI is mulling a 50 per cent cap overall with a 10-year lock-in as against the existing rules where banks are allowed up to 74 per cent and in this 49 per cent is by FIIs (foreign institutional investors) and 24 per cent by non-resident Indians. At present, the government treats banks with more than 50 per cent foreign shareholding as non-resident owned banks.  The RBI is also very clear about keeping real estate business houses out from trying for bank licences. “RBI has always been allergic to real estate as the bubbles are always created in the real estate market,” said HDFC’s Parekh.

While RBI’s move is certainly positive for prospective candidates, the skepticism is over the larger goal of achieving financial inclusion, which is one of their mandates for increasing the number of banking licences.  It remains to be seen how profitable banks and promoters feel about financial inclusion or inclusive growth.

Theoretically more licences should essentially mean more banks followed by more branches and ATMs but should it be in the un-banked areas is the moot question. After all, at the end of the day the capital is going to chase only profitable ventures.