Differentiated banks: has their time come?

July 27, 2014 11:13 pm | Updated 11:13 pm IST

The Reserve Bank of India on July 17 released >two separate draft guidelines for licensing of two new categories of banks — Payment Banks and Small Banks. It expects to receive feed back and comments on the draft by August 28. Final guidelines will be issued after receiving feedback. The practice of issuing draft guidelines first, inviting comments on them and then issuing final guidelines, is the standard procedure adopted by the RBI for framing policy guidelines on important issues.

Both Payments Banks and Small Banks are ‘niche’ or ‘differentiated’ banks with the common objective of furthering financial inclusion. Small banks will provide a whole range of banking products — deposits and loans — but in a limited area of operation.

Payments Banks will provide a limited range of products such as acceptance of demand deposits and remittances of funds, but will have a wide network of access points particularly in remote areas. It is expected that they will supplement their own network with business correspondents and even depend on network provided by others. Technology will be extensively used to add value.

Impetus to licence The impetus to licence ‘niche banks’ arises out of the need to spread financial inclusion in the country. It is estimated that almost 40 per cent of the population do not have access to any form of formal banking. Spreading the banking habit, accompanied by financial literacy, is a priority. Launch of these niche banks is an important milestone in the journey towards inclusion. That anyway is the hope.

The issue of beefing up the institutional structure to spread financial inclusion has been engaging policymakers for a long time. In fact, the two-stage bank nationalisation that began in 1969 had as one of its key objectives the spread of the banking habit through opening branches in hitherto un-banked areas. Regional rural banks (RRBs) can be considered to be one form of niche banks, concentrating on agriculture in a narrow well defined area. They were invariably promoted by full-fledged commercial banks. For a variety of reasons, RRBs never really took off, but from their experience plenty of lessons relevant for today’s niche banks can be drawn.

In January, the Nachiket Mor Committee mooted the idea of these differentiated banks as a means to further inclusion. It laid down an ambitious road map for attaining specific goals of inclusion. The RBI draft is partly derived from the committee’s recommendations.

Viewed in another way, licensing these differentiated banks is a logical follow up of the licensing policy for new private banks announced in 2013. Two applicants made the grade and the RBI decided to licence banks at more frequent intervals. It is in that context that the idea of differentiated banks was mooted. The latest budget has carried the idea forward.

Common features For both categories — Payments Banks and Small banks — the draft guidelines have some common features. The minimum paid-up capital is Rs.100 crore. Promoters’ initial contribution will be at least 40 per cent to be locked in for five years. The draft guidelines have prescribed a timeframe to bring down the promoters’ stake to 40 per cent within three years, 30 per cent within 10 years and to 26 per cent within 12 years from the date of commencement of the bank.

Obviously, the promoters of these banks will be ‘fit and proper’ and have a successful track record of at least five years in running their businesses.

Days after the guidelines were announced, the main point of interest has been on who would be the first to start these banks. According to the draft guidelines, entities eligible to start Payments Banks include non-bank prepaid instrument issuers, non-banking finance companies, corporate business correspondents, mobile telephone companies, supermarket chains and co-operatives Those eligible to start Small Banks include individuals with ten years of experience in banking and finance societies, NBFCs, microfinance institutions and local area banks

There can be no two opinions on the value of these differentiated banks to the Indian financial system. But the key question is how many serious promoters will finally emerge? The business model of Payments Banks may not be attractive enough. These banks can accept current and savings bank deposits but cannot undertake lending activities. After meeting the reserve requirements (CRR and SLR) like any commercial bank, they will have to invest in government securities. The returns in terms of the spread income may not be attractive enough. Although the guidelines do not say so, Payments Banks resemble ‘narrow’ banks entities, which were required to park their incremental deposits only in government securities. Such a model was prescribed in the early 1990s for the troubled government-owned Indian Bank, which was then reeling under loan losses. However, it was not found feasible.

Small Banks have an uncanny resemblance to the local area banks, which were launched with much fanfare in 1996. There were very few applicants in the first place, and by 2003, the RBI decided not to issue fresh local area bank licences.

Admittedly, what the RBI is thinking of are an entirely different breed of banks — with higher capital and greater access to technology. But will they be enough to kindle genuine interest among eligible promoters?


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