The Reserve Bank of India's move to open up the banking sector to more players comes at a time when the government is trying desperately hard to be seen as pushing policy reforms to stimulate the economy. Economic growth is slowing following a prolonged period of monetary tightening and growing uncertainties.
Looking at the optimism prevalent at the beginning of the current fiscal, not having a bank license could be viewed as a great opportunity lost. But now with the slide in the entrepreneurial spirits, many may be thanking their stars for not having had to lock in hundreds of crores of rupees in capital with little business to show.
The subject of new banks and related issues has been intensely debated many times over the years. New banks were to come in 2004, but didn't. They were to come in 2009, they didn't. Then in 2011, they didn't. This time, it seems these are certainly coming.
In a rare display of transparency, the RBI has disclosed the names of all 26 applicants, a motley group of Non-Banking Finance Companies (NBFCs), corporate heavyweights, government entities and broking companies,that applied for a banking license. One unusual applicant is the government’s own postal department. Six years ago, the department had suggested its transformation into a bank but that wasn’t cleared by the RBI. This time there has been a warm reception to the idea with few against the proposition.
The long wait for banking licences seems to be ending and all eyes are on how the RBI will select candidates for new banking licences. There are umpteen guesses. The stock market has been playing stocks up and down. Most experts are hopeful on LIC Housing Finance, NBFCs and government entities having significant penetration in rural areas and good inclusive track record, to win the banking licences.NBFCs are preferred by many as it would be a natural evolution for them. Some have preference for government entities like India Post across India.
However, on large corporations’ banking aspirations, the opinion seems divided. Some economists are giving the least priority to big corporates due to conflict of interest issues.
Despite “Chinese walls” being erected, some fear that the large companies know how to break them down. Joseph Stiglitz, the left-leaning Columbia University economics professor and Nobel laureate is of the view that it would be “very risky” to allow companies to own banks. “This was not allowed in the US, and rightly so. The conflicts of interest that it would open up were sufficiently great and regulators would not be able to circumscribe them easily — or at all”.
Similar views were voiced by the right-leaning economist Percy Mistry, who opines that allowing industrial houses to run banks would leave “massive scope for malfeasance”, citing example of Japan where banks and industries being enmeshed with each other, the country faced financial crisis for a long time. C Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council earlier suggested that while allotting new banking licences, RBI should start by issuing licences to “non-corporate businesses” first and look elsewhere only if there are no such qualified applicants.
The International Monetary Fund in its maiden Financial Sector Stability Assessment Paper (FSSAP) for India came out strongly against giving bank licences to corporate houses, citing a wealth of cross-country experiences. Most countries have neither framework nor capabilities for consolidated supervision of even bank-led groups. Such overall supervision becomes even more difficult when the group is engaged in non-financial activities on a significant scale. Frameworks for the oversight of financial conglomerates are still at the stage of discussion at the international level. India has to first put in place a framework for such supervision and gain some experience of running it, before it can think of allowing conglomerates into commercial banking.
It is also true that big corporates have deep pockets and management skills. With proper regulatory framework and avoiding such corporates who don't have finance as one of their main businesses and selecting others entering to enter banking may prove a game changer. The country direly needs number of big banks to keep pace with the requirements of the economy which are going to be huge notwithstanding the current slowdown, which is a temporary phase.
The RBI is likely to give around four private banking licences initially as part of a push to include more of the country's population in the formal banking system. Analysts said the central bank may be looking at companies with deep enough pockets to run a bank successfully. But there are scores of large corporate with market capitalization above 100 billion rupees. The central bank will decide as per its set conditions. Seems other companies, such as real estate developers which are reportedly keen as well, will be left out.
Even brokerage houses are likely to be left out. The financial services companies in the race will have the biggest challenge to manage the shift away from their existing business models.
In the new emerging banking scenario, new banks will have to act on the following
- Merge the group NBFCs under the banking arm
- Keep 23% of net owned funds in government securities and 4% in cash reserves
- Classify loans as bad if they are due for 90 days. NBFCs get 180 days
- Cap loans to risky sectors – real estate and stock markets
- Seek prior approval from the RBI to set up branches
- Lend 40% of their advances to priority sectors such as agriculture
- Meet strict norms for lending to group companies
- Adhere to stiff Basel-III capital requirements
It will be a whole new ball game with stricter guidelines. Apart from the transition trauma, challenges would be many like gaining size, establishing a strong brand identity amid stiff competition from existing players and most importantly adapting to a tightly regulated sector.
What India needs are a number of big banks having bigger balance sheets so that they can lend more. The RBI needs to think long term and to fit the current decision on new banks in its broad and holistic road map of the banking structure of the future.
The author is a corporate economist and sustainability analyst. Views expressed are personal