The Reserve Bank of India’s discussion paper on the evolving banking structure in India is timely. The RBI is contemplating licensing new banks in the private sector.
It has received 26 applications, and is now scrutinising them after which they will go through an external scrutiny.
While the actual awarding of licences might take some more time, a discussion on the evolving structure of banks has become necessary.
The crucial issues that are relevant for the evolving banking structure are enhanced competition, financing higher growth, providing specialised services and financial inclusion — all these “in the backdrop of a strong regulatory and supervisory regime with increased intensity of supervision for the systematically important banks”.
The discussion paper has identified 10 specific issues that will have a bearing in any future banking set-up. A few of these overlap, as for instance, the topic “small banks v large banks” and “consolidation”.
Small banks — the term has not been defined anywhere — have their uses, such as in extending banking to un-banked areas. They play an important role in financing agriculture and small scale units. However, while permitting a large number of small banks, the RBI has to be concerned about their governance, regulatory norms, capital requirements, and so on.
Consolidation, the way forward
That is why, though in a different context, consolidation of banks has been recommended.
A few large Indian banks, it is claimed, can serve the interests of a global clientele and fund infrastructure projects. Even the largest Indian bank, State Bank of India (SBI), is not large enough by global standards.
In general, merger of two public sector banks (PSBs) raises some daunting issues, especially in managing the staff. Fortunately, the RBI discussion paper is not dogmatic, and, in fact, warns against forcible consolidation. Market-driven mergers among private banks are in an entirely different category, however.
A discussion on mergers and amalgamations in the banking sector leads to the issue of what the banking structure would look like after it is “re-oriented”.
The discussion paper identifies four tiers: the first tier consisting of 3 or 4 large banks with domestic and international presence along with branches of foreign banks; the second tier likely to comprise several mid-sized banks, including niche banks; the third tier made up of old private banks, regional rural banks, and multi-state urban co-operative banks; and the fourth tier made up of small privately-owned local banks and co-operative banks.
However neat the above banking structure will look, there will be definition and classification issues that will have to be sorted out.
The RBI discussion paper envisages a major overhaul of the licensing policy: instead of the current “stop and go” licensing, there should be a procedure for “a continuous authorisation”. There will not be any bunching of applications.
Additionally, existing banks will be put on notice of new competition. But the proposal will succeed only if it is transparent.
Two other important issues are: universal banking and government ownership of banks.
Universal banking, as was promoted a decade ago in India with a lot of hype, involved conversion of the branch of a commercial bank into a kind of financial supermarket offering a variety of products and services in addition to deposit-taking and lending, products such as home loans, share market services. For a variety of reasons (such as absence of skill-sets among staff and regulatory issues), the idea of universal banking never really caught on.
Those who claimed to be universal banks have common logos across a range of products but stopped short of offering all services. (For example, credit cards and insurance are handled through subsidiaries.)
The Financial Holding Company (FHC) model will be in a better position to regulate and supervise. Additionally, in a changing environment, there is a case for differentiated licensing — separate licences for say infrastructure funding can be considered.
On government ownership, there is very little new that the RBI discussion paper has to say.
Government can issue shares with non-voting rights to retain control while simultaneously enabling public sector banks to raise capital.
By many viewpoints, the role of government in any future banking set-up will be the most important factor impinging on the general level of competitiveness and financial stability.