Posted in Finance Articles, Total Reads: 3020
, Published on 08 June 2013
Banking system is the heart of an economy, with the capital provided by it synonymous to the blood in veins. The health of an economy depends on the soundness of its banking system. This is the reason that every time a recession or an economic slowdown occurs, banks are the first ones to be bailed out by the Government. Major functions of banks include mobilization of savings, capital formation, economic monetization, promotion of employment and entrepreneurship, rapid economic development, raising the living standards, safety of wealth, remittance of money and saving of precious metals.
Brief history of banking in India
Indian banking sector depicted a picture of ‘financial repression’ till 1991 with Government having a domineering role in economic activity and ownership of banks. They mostly catered to the needs of planned development, with automatic monetization of fiscal deficit, and were subjected to large pre-emptions, both in the form of statutory holding of Government securities as well as administrative direction of credit to preferred sectors.
The banking reforms started in the 1990s, and have continued till date. The Narasimham Committees, appointed in 1991 and 1998 focused on providing greater autonomy to public sector banks and reform in the role of RBI (to act as the regulator and not the owner). Some key effects of the report were:
Strengthening the banking system through merger of large Indian banks
Decrease in non-performing assets by eliminating poor-credit decisions
Creation of Asset Reconstruction Funds (ARF) or Asset Reconstruction Companies (ARC) to take over the bad debts of banks
Tightening the provision norms by raising the Capital adequacy ratio
Softening the norms to allow entry of foreign banks in India.
Comparing with China, where banking sector reforms started late with limited amount of interest rate liberalization happening in 2012 and Chinese Government still holds a major stake in the largest Chinese banks with a considerable influence over banking activities. However, Chinese banks’ profitability and capitalisation, along with the assets performance measures have improved considerably over the past decade.
Need for new banks
The no. of commercial banks has reduced from 274 in 1990 to 169 in 2012, while the no. of branches has increased from 59,752 in 1990 to 96,059 in 2012. The population per office has reduced from 14,000 in 1990 to 12,800 in 2012. However, the no. of rural branches has remained the same, while the major increase has been in terms of urban and metropolitan branches.
Breakup of Banks Source:RBI
Currently, 26 public sector banks and 20 private sector banks operate in India. 6 of the PSBs operate under the State Bank Group. The private sector banks include 13 old banks, which existed before 1991 and were not nationalized at the time of bank nationalization during 1969 and 1980 because of their small size and regional focus, and 7 new banks which came into existence after 1991 (post liberalization). Apart from these, 41 foreign banks and as many as 82 regional rural banks operate in India.
Loan Assets of Banks Source:RBI
The cash deposit ratio has dropped down from 16.3% in 1990 to 8.17% in 2011 and further to 5.79% in 2012. The investment-deposit ratio has been in the range of 35%-48% during the last 2 decades, attaining a maximum of 47.3% in 2005, and reaching 34.56% in 2012. The credit deposit ratio, which reflects the management performance of banks, has increased after liberalization, from 61.6% in 1990 to 78.6% in 2012.
Graph 2: Credit Deposit RatioSource: RBI
40% of India’s vast population of 1.2 billion has no access to banking services. Though India is on its path to liberalization since past twenty years, hardly a dozen private sector banks have been licensed in the last two decades. Moreover, the stringent capital requirements have made it difficult for the existing players to expand their loan assets. A large chunk of existing population, including low-income families, small businesses and truck drivers are not being served well by the banking system. Only 35% of the population has formal bank accounts versus a global average of 50% and an average of 41% in developing economies. Hence, the need for financial inclusion calls for more banking licenses to be granted and hence many more competing banks to penetrate the rural market and provide financial services, at affordable costs to every section and corner of the country.
A significant coverage jump for financial inclusion requires large investments. The Government, holding a major stake in the banking sector, is short of excess funds and is not ready to dilute its stake. Therefore, new banks are a must in order to increase the capital base and provide financial access, not only to the individual customers, but also to small-scale industries devoid of finances till date.
Key features of guidelines for licensing of new banks
Figure 1: Requirements for banking licence Source: RBI guidelines
RBI has allowed applications from public and private entities as well as established NBFCs thereby countering the widespread speculation that private promoter groups shall be ineligible to enter the banking arena on grounds of possible conflicts of interest. Nevertheless, it has aptly introduced criteria as discussed below to keep them in check.
Non-exclusion of sectors
The outright exclusion of broking and real estate sectors that was present in the draft guidelines was diluted to a generic caution to businesses that are speculative or experience high asset price volatility. The rationale behind the move is that such practices are inconsistent with the banking business. Although this open ended guideline leaves room for assessment of individual entities by RBI who may look into the share of earnings of the applicant group from such groups, it has left the aspirants of this sector ripe with uncertainty.
‘Fit and Proper’ criteria
This incorporates the credentials and integrity displayed in the past, financial soundness, success in running the business as well as the fitness of business model of the promoter group for running banking business. All in all, this is a subjective assessment criterion which would give RBI sufficient flexibility and independence in the process. Although, it may have to travel a troubled track because this may result in allegations of unfair practice and lack of transparency post the award of licence.
The new bank would be set up through a Non-Operative Financial Holding Company (NOFHC) wholly owned by the promoter group which would include all the financial services entities of the group. The minimum paid up capital is specified as Rs 500 Cr while the NOFHC can have a lowest share of 40% in the bank which is slated to come down to 15% in 12 years.
Options for bank licence to NBFC’s
If all the services offered by NBFC come under the purview of new bank, it can convert to a bank. On the other hand, if it has some activities which cannot be taken up by the new bank, the NBFC can either divest those activities and convert to a bank of keep the activities and promote a new bank.
Foreign shareholding cannot exceed beyond 49% for the first years after which it will be in line with the policy present at that time.
The NOFHC cannot have any exposure (debt or equity) to any arm of the promoter group
Majority of independent directors are mandated.
At least 25% of the branches have to be opened in currently unbanked rural areas with a population less than 9000. This is in line with the objective of financial inclusion.
Figure 2 Timeline of new round of banking licence Source: RBI guidelines
The road ahead
The Government of India and RBI have displayed cooperation and solidarity to remove obstacles to the issuing of banking licence as it is both a growing need for banking services as well as to serve the goal of financial inclusion. After the release of the guidelines, the aspirants have been given time for application which would be referred to a high powered committee subsequent to screening by RBI. Based on its recommendations, the RBI will have the final say on allotment of licence. In order to ensure that the procedure is absolutely fair and well understood, RBI has decided to issue clarifications to queries of intending application, who can seek it by 10 Apr, 2013. Given that 3 years have already passed to release the guidelines since a first mention of new licences was made Finance Minister of India in 2010, it would need massive efforts to successfully roll out the licences by end of FY 2013-14.
Article has been authored by Sankalp Raghuvanshi and Prateek Vijay Gupta from MDI Gurgaon