Banking bill: A test case for consolidation

Banking bill: A test case for consolidation

Nearly 12 years after the Reserve Bank of India allowed new players to enter the banking space, the process of granting licences is likely to start soon. This will not only give the government’s ambitious financial inclusion plan more teeth, but also pave the way for large global banks to start operations in Asia’s third largest economy.

The last time RBI allowed new private banks to spread their wings on Indian soil was in 2002, prior to which it allowed new players in 1991-92 when the first flames of liberalisation were being fanned by a gale of unprecedented policy initiatives.

Thereafter, despite 20 years of a sustained reforms drive and reasonably high economic growth, India is among the most-under banked nations among the world's bigger economies. This is evident from the fact that India’s loan-to-GDP ratio is just 75 per cent, whereas China has 146 per cent, United Kingdom 214 per cent and USA 233 per cent.

Among developing countries, Brazil has a loan-to-GDP ratio of 98 per cent, according to RBI data, which is better than that of India. The quantum of domestic bank loans disbursed as a ratio of GDP gives a fair idea of the degree of banking penetration in a country.

The low penetration of the Indian banking system has hampered the sector's growth in the past.

However, according to economists, the narrow banking outreach will affect the economy more going ahead, as India moves into a decade where infrastructure financing will attract huge attention. India envisages $1 trillion expenditure on infrastructure in the next five years. “It is critical for India to have more banks, whether through setting up new banks or expanding existing ones. If $1 trillion worth of infra investment is needed, we certainly need big and stronger banks,” says Naina Lal Kidwai, President of the Federation of Indian Chambers of Commerce and Industry (FICCI).

Finance Minister P Chidambaram had recently pointed out that no Indian bank is among the top 20 banks in the world, whereas neighbouring China has at least three. There is unanimity among policy makers and economy watchers that India -- for the size of its GDP and the future it envisions -- needs more strong banks, not to mention a few banks of global dimensions.

Besides, domestic banks face other problems too, for which the Banking Bill was a necessity to be pushed through. Though some Indian banks have performed well on the asset quality and profitability fronts, several notable limitations such as restrictions on capital availability, weak corporate governance and the fragmented nature of the banking industry have posed impediments in the way of the sector's growth.

The new Banking Bill passed by Parliament last week also paves the way for state-owned banks to raise capital to expand their base through rights issues and issue of preferential or bonus shares without being limited by the earlier ceiling of Rs 3,000 crore.
As of today, nearly 70 per cent of the banking business in India is conducted by public sector lenders.

Capital infusion in these banks is done by the government on a periodical basis to ensure their growth and further expansion. But, with increase in their capital requirements over time, it has become important that these banks enter the capital market on their own. This will help reduce public funding of new social sector programmes and help ease pressure on the government’s constrained revenue flows, analysts opine.

Other important provisions after the amendments to the Banking Bill are that the RBI will have powers to inspect the books of all associates and subsidiaries of a banking company or any corporate house foraying into the banking business. For example, if a 'Tata Bank' is set up by the Tata group, the RBI will have powers to call up the books of Tata Steel or Tata Metaliks for inspection, even if these entities are not related to Tata Bank. The bill gives the regulator powers to supervise connected lending as well. Analysts note that this will save public money from being siphoned off by fly-by-night operators.

In cases of largescale fraud, the bill gives RBI the power to supercede the entire board of a bank. In 2004, Global Trust Bank ran into serious ethical issues and was merged with Oriental Bank of Commerce. At that time, RBI did not have rights to take over the bank’s board and had to find a buyer for the sinking bank within a day. Once the bill comes into law, RBI will have greater flexibility in dealing with banks who crack up under fraudulent practices.

The bill also enables government to raise shareholder voting rights in public sector banks to 10 per cent from 1 per cent now, acceding partially to foreign investor demands for a greater say in Indian banking. Bank employees unions who are strongly opposed to this move resorted to protests last week. Taking to Deccan Herald, General Secretary of the All India Bank Employees Association C H Venkatachalam said, “10 per cent voting rights to private shareholders will mean that their voices will be heard 10 times more. Private shareholders will now demand more dividend and will be least concerned about fare utilization of public money."

In the case of foreign banks, the bill has accepted their longstanding demand to be allowed to convert their Indian operations into local subsidiaries, or transfer their shareholdings to a holding company of the bank with exemption granted on stamp duty. Currently, foreign banks pay 20-30 per cent tax on capital gains and stamp duty while transferring their branches to a new legal entity.

The bill has dropped a controversial clause which would have allowed banks to enter into forward trading, but paves the way for a greater banking presence in the rural areas. More banks in rural India will also mean more job creation, the government says.
The bill will also sooner or later pave the way for consolidation in the banking space with the entry of some large players, a fear which has drawn opposition and ire from bank unions in equal measure. According to Venkatachalam, India needs expansion of its banking sector, not consolidation.

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