New banks: Room for serious players with financial muscle

Contrary to expectations, the announcement turned out to be a damp squib when the Reserve Bank of India on Monday last released the  list of 26 applicants – including top industrial houses like Tata, Birla and Anil Ambani’s Reliance group – looking to establish full-fledged banks in the country after a gap of a decade.

Despite all the tom-tomming, the final list submitted with the central bank was smaller than anticipated. In contrast, earlier, when the RBI opened the doors for new banks in two phases, they had got as many as 113 applications in 1993 and over 100 applications in 2003.

Speculation in Mint Street circles this time round was that everyone was keen to enter the sector as the lure of banking lies in the ability to raise low-cost deposits and generate fat margins,  which is 3.5 per cent for private banks -- among the highest in the world. Another carrot is the huge business opportunity since half of India’s adult population does not have access to formal banking services.

Domestic banks in India are considered to have clean, strong and transparent balance-sheets relative to other banks in comparable economies of Asia. The rationale behind RBI allowing new banks is simple: foster greater competition, reduce costs and improve quality of service.

But this time, RBI wants more ‘financial inclusion’ as unbanked areas in India are large and a vast number of people in rural areas still have no access to scheduled banks. Ironically, RBI’s discussion paper never argued out the need for more (private) banks and why financial inclusion cannot be served by expanding existing banks. One school of thought is that the government could not have achieved financial inclusion on its own given its compulsions of containing the current account and fiscal deficits.

The debate on whether the bank nationalisation by former prime minister Indira Gandhi in 1969 was ‘political’ or ‘social’ remains inconclusive, but one cannot overlook the quantum leap in jobs generation back then and branch expansion soaring from 8,000 in 1969 to 32,000 in 1980 and then to 60,000 in 1990. This in turn led to a steep rise in savings rate – after all, savings is about what comes into the financial system without being locked up in household cupboards – and set the stage for a growth rate of 5.5-6 per cent during the eighties.

Similarly now, the government assumes that a set of new banks will strengthen and expand the industry and add to the resilience of state-run banks, which now account for about 70 per cent of India’s Rs 75-trillion banking industry.

Financial inclusion

Nevertheless, RBI’s insistence on financial inclusion in terms of branch placement and liquidity will constrain profitability and scale. For one, new banks must keep 27 per cent of deposits with RBI and in government bonds during their startup years, which implies that they can lend only Rs 73 out of every Rs 100 raised by way of deposits. Secondly, one in four branches must be set up in rural areas where few banks exist – a tall order for some applicants.

Those requirements are the same for existing banks as well, but then the rules were implemented after incumbent lenders had already built up scale. In short, the rural branch criterion is applicable only to new banks and could put off candidates even after they get licences from RBI.

Getting RBI’s approval is a beginning and not a goal in itself. Not all ‘fit’ candidates will get licences to start a bank. “…Internally, we will evaluate the applications in the next 3-4 months and then we will remit this to external committee to stream the applications which will then make a decision. We have to see the quality,” said RBI Governor D Subbarao at the bank’s Chennai board meeting. And, RBI is yet to set up a committee to scrutinise the applications.

Some may find the going tough with 40 per cent priority sector lending norms, even though they have three years to meet them. Strict conditions mean profitability for new banks will be limited till they secure a strong foothold, while transformation of existing franchises will be slow too, as most of them will have to start from scratch.

With very few rural branches, financial inclusion will remain a challenge and will come at a cost as one needs to make huge investments in the retail business with returns taking longer compared to corporate banking. It will be a long haul: only serious candidates with adequate financial muscle and strong management will achieve the goal in the long run.

Groups like Tata, Birla and Anil Ambani’s Reliance group, armed with the much needed financial muscle, will have an advantage as they can explore the synergies between their telecom networks and banking services while operating their services in the rural hinterlands.

A stricter RBI regime may curb the number of new banks but the moot question is how far it will impact existing players. Veteran banker and HDFC Chairman Deepak Parekh, while declining to speculate, maintains that new banks as and when they come won’t disrupt or impact banking operations of existing players.

To lure depositors and retain them, new banks will still have to offer higher deposit rates. Currently, most PSU lenders pay 4 per cent interest on savings deposits while newer banks – like Kotak, IndusInd and Yes Bank – give 6-7 per cent.

More licences would generally mean more banks, branches and ATMs; but against the backdrop of ‘financial inclusion’, it will have to be in unbanked areas – more so in villages and hamlets. It will thus be a challenge for new banks. At the end of the day, their capital will have to chase only profitable ventures to stay afloat and succeed in the long run.