A day after reviewing the credit policy statement on April 1, the Reserve Bank of India (RBI) announced its decision to award ‘in-principle’ approval to two applicants, IDFC Limited and Bandhan Financial Services Private Ltd., to set up banks. These two successful applicants will now proceed to set up full-fledged banks under guidelines issued by the RBI on February 22, 2013. They have 18 months to comply with the requirements under the guidelines and any other stipulations that RBI might prescribe.

Senior officials from both the institutions have been keenly aware of the tasks on hand. They have very different profiles at present. In their march to full banking status, they would naturally leverage on their existing strengths — infrastructure in the case of IDFC and micro finance for Bandhan. The tasks look daunting but achievable within the given timeframe.

The last private bank licences were awarded ten years ago in 2004. Kotak Mahindra Bank and Yes Bank came into being. At the start of the reform era, several licences were given to private players to set up “new generation private banks”. These were expected to be very different from the already existing private banks, in terms of technology, capitalisation and so on.

However, in the reform context, it is easy to see that these new banks were licensed specifically to be a model for the public sector banks, which continue to be the dominant force till date.

Pedigree matters most

It is difficult to generalise but the performance of the new private banks as a class did not match the expectations of them. More significantly, only a few of them have survived, the others being gobbled up by stronger private banks. One high-flier, Global Trust Bank, had to be rescued by the government-owned Oriental Bank of Commerce. And the CRB fiasco, when a totally undeserving non-banking finance company was given an in-principle clearance to start a bank, is still fresh in our minds.

One message from the more successful ones is that their model has not been inclusive. Using technology and starting with a clean slate they have created a new paradigm essentially for the well heeled. How far their success in niche areas is relevant to bank licensing today —with its emphasis on financial inclusion — is to be seen.

Interestingly, the more successful banks set up in the 1990s and thereafter are those with good pedigree.

All the above provide an explanation as to why the process of issuing private bank licences has taken so long. The RBI has, for very valid reasons, been conservative. Bank licensing is a sensitive subject always. More so when private players, including corporates, were to be considered. In fact, the suggestion to include corporates among those who can bid has been the most controversial. The RBI itself was opposed to it and most of the responses to the discussion papers were not in favour.

Those who oppose granting bank licences to corporates are on a sound wicket. Recent economic history is on their side. Banks were nationalised in two phases beginning 1969 to end the corporate owners’ stranglehold over major banks. Whatever else might have been the pitfalls of nationalisation, it ended the cosy relationship between bank managements and corporates.

It was in 2010 that the then Finance Minister, Pranab Mukherjee, first mooted the proposal to issue a few private bank licences in his budget speech. The RBI circulated discussion papers and elicited responses from a wide range of people. Guidelines were framed after that. After two of them withdrew, 25 were considered. The first round of scrutiny was done at RBI. To further vet the applicants who meet the eligibility criteria and also to avoid any bias, the RBI appointed a High Level Advisory Committee (HLAC) headed by former RBI Governor Bimal Jalan. It is on the basis of this committee’s recommendations that the first two licences were awarded.

The RBI has done everything right. The two successful applicants are non-controversial. As to the criticism that the RBI could have waited until after a new government is formed, the Governor had said that the entire process might have had to be revisited in that case. Considerable ground had been covered and the whole procedure has been above board. Despite some big names among the corporate applicants, the RBI has played it safe by giving in principle clearances to entirely non-controversial non-banking finance companies.