If at all the industrial houses are allowed to set up banks, certain safeguards must be observed
The Reserve Bank of India has received huge responses to its discussion paper on ‘Entry of new banks in the private sector'. The subject — licensing new private banks — is extremely sensitive. No matter how cautiously the central bank frames the policy, the final selection will be controversial for many reasons.
Public sector banks hold a dominant share in the domestic banking business (almost 70 per cent). It was not always so. Until 1969, barring State Bank of India and its subsidiaries, all leading banks of today — Bank of Baroda, Bank of India, Punjab National Bank and so on — were in the private sector. For reasons that have as much to do with politics as economics, the government took over the large banks after subjecting them to a period of social control.
The decision to nationalise banks (the two-stage process began in 1969) might be controversial but one important factor cited in its favour was that it brought about a radical change in Indian banking. Social banking, a vast expansion of bank network and many other objectives that were not strictly related to profit maximisation, became the goal. These objectives had remained through the reform era, whose most distinguishing feature was to spur competition in the financial sector. New private banks, with large investments in technology and high-level of capital adequacy were licensed.
This significant reform era policy change, which brought in the ‘new generation' private banks, however, offers very little guidance to the latest move to license a few more banks. The lesson learnt is that the only successful private banks are those promoted by well established institutions. Is it possible to find a similar set of promoters willing and able to build a new private bank?
The promoters' background will be the most critically watched area and is something that cannot be vetted or satisfied by merely raising the bar — by way of higher capital, promoters' contribution or up-to-date technology. But there are other criteria that will equally be challenging.
Realising these, the discussion paper merely reviewed the international and Indian experiences on six broad issues: minimum capital requirements and promoters' contribution; minimum and maximum caps on promoters and other shareholders; foreign shareholding; whether industrial and business houses could be allowed to promote banks; whether NBFCs be allowed to or be converted to a bank; and business model for the new bank.
All these issues admit several sharply differing viewpoints. The discussion paper, to generate as wide a feedback as possible, had merely spelt out the pros and cons of different approaches, without itself committing to any fixed position.
Gist of the feedback
Should large industrial business houses be allowed to set up banks? Not surprisingly the most controversial issue specified by the discussion paper has elicited the largest number of responses.
Among the arguments against giving bank licences to big business, the past unsavoury record in India and abroad. Combining banking and commerce has not been a happy experience in many countries; it may lead to connected lending; regulators will have to face new challenges; the ownership structure of large industrial houses may give rise to regulatory arbitrage; and allowing industrial houses to own banks will exacerbate the existing concentration of economic power in this country.
Those who favoured for new licences say that big businesses by providing large capital will enable new banks to further objectives such as financial inclusion. Besides, already in certain important areas such as mutual funds and insurance big businesses have had a reasonably satisfactory track record.
If at all the industrial houses are allowed to set up banks, certain safeguards must be observed. These include impractical suggestions such as prohibiting the new bank from having connection with the new group. As a general rule, such entities ought to be more tightly regulated. In any case, only those business groups with impeccable integrity and standing should be permitted.
Permitting NBFCs to convert themselves into banks or promote new banks is another debatable issue. One leading industry association has opposed the idea, citing the difficulty in aligning an NBFC's business model with that of a bank.
NBFCs are a diverse lot and it is only fairly recently that the central bank has extended its regulation over them. Many deposit taking NBFCs did not survive the first major regulatory hurdle — a requirement to have an investment grade rating for their deposit schemes. However, should they be allowed to start new banks, they should be asked to wind up such of those activities that overlap with commercial banks in a phased manner. That is because NBFCs are lightly regulated, compared to banks and regulatory arbitrage might accrue.
As regards the business model that the new banks should adopt, the dominant view of industry associations and banks was that only general banking licences should be given. Restricting the new banks to a specific geographic area or to one objective such as financial inclusion will make them unviable.
The RBI has received a number of responses on the other issues raised in the discussion paper. On the minimum capital requirements for the new banks, suggestions have varied from a high start up capital of Rs.1,000 crore (industry associations and banks) to Rs.300 to Rs.500 crore (micro-finance institutions and NBFCs). The suggestion on initial promoters' contribution has ranged from 30 to 100 per cent. It is likely that a consensus on these as well as on foreign shareholding will be reached more easily than on the contentious issue of industrial houses to start banks. It is just as well that the RBI has already decided than an independent expert group will vet and recommend eligible applications to the RBI.
C. R. L. NARASIMHAN
The wide range of opinions in the feedback to the RBI's discussion paper show how controversial will be the policy guidelines regarding new banks.