The Reserve Bank of India has recently placed in its website a discussion paper on granting new bank licences to select private sector players. As intended, the paper has stirred a wide range of debates. It would never have been easy for any one to frame guidelines for the entry of new private players into a sector, which for various reasons, has been considered to be controversial.
Though overwhelmingly dominated by the public sector even after two decades of financial sector reform, the possible entry of a few private players remains a sensitive subject. One reason, of course, is that, however fine-tuned the eligibility criteria might be, they are unlikely to meet with universal acceptance.
In fact, the controversial nature of the topic has made the RBI issue a detailed discussion paper. It is certainly desirable that the regulators elicit a wide range of views by first making public draft guidelines or as in this case a discussion paper. The RBI has recently placed for public discussion a paper on credit default swaps. Other regulators, the Securities and Exchange Board of India notably, have invariably been following this step-by-step approach. (A set of draft guidelines on the takeover code has been thrown upon for discussion.)
Yet, the 81-page discussion paper on new bank guidelines seems different. It covers familiar ground on recent banking policies and discussions. Significantly, the key points — allowing industrial houses to promote banks, minimum capital for new banks and elevating non-banking financial companies — are discussed threadbare but there is very little indication of what the RBI thinks the final policy stance should be. Pros and cons relating to each of these are laid out. Some arguments are fairly elementary but are justified. The central bank probably wants to involve the common man who should, therefore, be given a kind of background paper free from bias.
RBI tries to be objective
There was another indication that the RBI would maintain an impartial stance right from the start of the exercise.
Much before the discussion paper was circulated, it was announced that an independent expert group would recommend to the RBI eligible applicants on the basis of the approved criteria. That is meant to demonstrate the RBI's resolve to deal with the subject in an impartial way. But can subjectivity be totally eschewed? Sanctioning a bank licence is in many respects like taking a major credit decision. The parameters — the balance sheet size, net worth, experience and so on — are no doubt very material but the subjective considerations are paramount, even if they are not disclosed.
Recent banking history
Guidelines for new banks were issued in 1993 following which ten new banks came into being. Four of these promoted by institutions — ICICI, IDBI, UTI and HDFC — have flourished. But the record of banks promoted by individuals has been unimpressive.
Out of the four banks promoted by individuals in 1993, only one has survived with muted growth. One bank has been merged with a nationalised bank. The other two have voluntarily amalgamated with other private sector banks.
Merger with stronger banks was the only course adopted by the majority shareholders to save the banks.
An important inference from the functioning of private banks over the past 17 years has been that banks promoted by individuals, though professionally qualified, have either failed or merged with other banks. Only those banks that had adequate experience in broad financial sector, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank. The criteria laid down for the new generation private banks have been quite stringent — minimum capital adequacy of Rs.200 crore to begin with; maintaining capital adequacy of at least 10 per cent on a continuous basis; and at least 25 per cent of the bank branches to be in rural and semi-urban areas. New bank licences, if anything, will be even more stringent. It will be interesting to see how many new applicants fulfil these and other criteria and equally importantly flourish thereafter.
A few other eligibility criteria and related issues connected with new bank licences need to be discussed at length in a subsequent column.
These include permitting industrial houses to start banks, minimum capital adequacy and conversion of NBFCs into banks.