What deterred new banking aspirants?

With the receipt of applications for banking licenses for the third batch of new generation banks by the Reserve Bank of India (RBI), the clock is ticking. In 1993, when the banking sector was opened up to private entities, 113 applications were received, followed by nearly 100 applications in 2003. The response to the latest round has been lukewarm, with only 26 applications. 

Earlier, Morgan Stanley, UBS, and Goldman Sachs got RBI licenses  for establishing banks in India after a lot of lobbying, but they later surrendered their licenses. For foreign banks, commercial banking services do not form part of mainline activity. Hence, this coupled with RBI's policy objective of financial inclusion, might have deterred them from going ahead with their banking forays.

Financial inclusion and rural banking mandates for 25 per cent of branches in rural areas are deterrents for those wanting to effect quick value creation, particularly in a service-oriented banking industry where it may not be easy and feasible. Capturing retail banking is a long-drawn process and returns are normally delayed, compared to lucrative corporate banking. 

For banks to start operations within 18 months of RBI's nod is a tough task unless the business entity already has a sizeable network in place and can stretch its financial strength. 

Banks distressed assets, consisting of what is known now as Restructured Accounts and Non-Performing Assets, constitute nearly 10 per cent of the Rs 40 lakh crore advances circulating in the banking system. Gross as well as net NPAs are on the rise beyond the thresholds of 3 per cent and 1 per cent respectively while Return on Equity is below 15 per cent; no wonder that the many banking stocks are trading well below their book values.

Despite repeated pleas from the SBI chairman, RBI has categorically ruled out paying interest on CRR and further stated that the mandate on CRR is being revised from time to time, depending on the liquidity review conducted by the central bank. Therefore, it is clear that CRR and SLR requirements are to be put in place by banking license aspirants right from Day One with no forbearance granted by RBI. 

Moreover, mandating that 40 per cent of net bank credit should go to the priority sector -- consisting of loans to farmers and small business -- may not be make good economic sense at first, though it holds business potential in the long run. 

While foreign investments in banking have been capped at 49 per cent, minimum capital requirement is kept at Rs 500 crore, which may not be a tough task. But, other conditions are tight and demanding. Promoters of a new bank can float the bank only through a holding company which should not operate as an independent business entity; and, no two promoters can jointly float a holding company to manage the bank; the bank should mandatorily list on the stock exchanges within three years; there should be gradual reduction in promoter stake to 40, 20, and thereafter, 15 per cent within a stipulated timeframe of 5, 10 and 12 years respectively. The exit route specified for the promoters in the 2013 license round is also abrupt in comparison with previous rounds.

By entering the banking sector through a Non-Operative Holding Finance Company (NOHFC), business groups may have to expose themselves to greater scrutiny or surveillance from RBI than they would otherwise, as RBI may become an uninvited guest exercising its right to scrutinise at will. Micro-management by RBI may not be welcomed by many business groups as the apex bank is famous for its globally recognized regulatory measures.

Though the licensing tranches started nearly 25 years after bank nationalisation in 1969, one in 11 applicants and one in 50 got RBI banking approvals in 1993 and 2003 respectively. Ten entities were granted approval in 1993, while in 2003, that was whittled down to just two applicants. But this time, the ratio may improve, as the base number is low at just 26 and the government may be keen to enlarge the banking network owing to its financial inclusion commitments. 

Of the 1993 lot, banks like Times Bank, Global Trust Bank and Centurion Bank did not survive. In the case of Global Trust Bank, the rule was changed, while in the case of CRB, it proved to be an improper selection mechanism. The pedigree of the business group now plays an important role with the RBI while taking a decision.

RBI's screening may be very tough this time, given past experience. Presently, only seven new generation banks from the past have survived -- IndusInd Bank, ICICI Bank, IDBI Bank, HDFC Bank, Axis Bank, Kotak Mahindra Bank and Yes Bank.    

Even as whatever is permissible under law cannot be practiced as corporate governance, whosoever is eligible to apply for a license does not become automatically qualified to be considered favourably, a stand reiterated by the RBI governor. 

The margin squeeze caused by depositors coveting high interest rates, coupled with borrowers bargaining for low interest rates and being made unwilling partners in meeting the government’s target of financial inclusion and rural development, will have a telling effect on business models of those approaching RBI for banking licenses. Banks have to choose between a devil or deep sea approach while running their operations, maintaining their profits.   

(The author is a chartered accountant and banking analyst)