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New Licenses In Banking Sector – Opportunity or Threat?

Posted in Finance Articles, Total Reads: 10124 , Published on December 29, 2011

The new bank licenses, up for grabs, are set to actuate a new epoch in tenacious Indian banking sector by inducing fresh blood in the markets. India is meticulously progressing in the global financial game that is dominated by the likes of Uncle Sams and John Bulls.

New Banking License

If the question is does India need more ‘banking’ in its political territory? Then the answer is yes, from the view point of tapping humongous population involved in virtue of deposits and bolstering the high growth that is targeted by channelizing funds for progressive use and most importantly, making it inclusive. Succinctly put, India deals with a financing model that is predominantly bank-oriented, which is crippled by the absence of debt market and hence reckons on the banking system as a source for funds for both short and long term growth.

India's economic growth continued despite some modest moderation, during the recent global recession that unearthed in notable advanced economies. RBI's cautious credit policy, kept the economy on growth track ensuring balance of price and financial stability.

The commendable performance of Indian banking sector is translucent on the global front as none of the Indian Banks made it to the top 50 banking institutions of the world. The excuse cited by Indian banks is the paucity of capital. Stakeholders including Government are in no mood to beef up the capital in order to ameliorate Indian banks’ status, worldwide. If India Inc. successfully rakes in colossal capital, new Indian banks would inch closer to a striking distance of laurels round the globe. This justifies the need for expansion in the banking industry and thus the issue of new banking licenses to India Inc. is a welcomed step by the central bank, RBI.

As every action in an organized system has its own pros and cons, issue of new banking licenses too has its opportunities and threats lined up.  Few opportunities are as follows:

Financial inclusion:  No country can attain sustainable growth if the population is deprived access to the financial system. RBI, well acquainted of this fact, has convened the Khan Committee in 2004. But 87% of branches in rural area being loss making, existing banks are pondering to open branches in unbanked areas.

RBI’s Monetary Policy Statement – April 2011 mandates the allocation of 25 % of the total number of banks’ branches in unbanked rural areas. New banks with their capital and regulatory guidelines of RBI will propagate financial inclusion of unbanked population.

Product innovation is taken up by a firm to tackle the threat to their current market share or when new firm is set to disturb the market composition. With 74% of total assets held in possession with public sector banks,the rate of product innovation may turn sluggish and is driven primarily by private banks. With new banks, innovative products are the need of the hour in order to warrant their market positions’. This trend proved to be successful in countries like Argentina, Russia and Brazil. Innovative products help providing choices to the customer comforting his needs.

Operational efficiencies through the use of Technology: The new entrant in banking sector will try to outplay the existing banks by taking advantage of efficient business models and latest technology available. New-fangled cost cutting techniques help new banks reach their pre-set targets well within prescribed time.

Decrease in concentration risk (“Too big to fail syndrome”) the problem of “Too big to fail” is that when few banks control major chunk of market, they infuse a reckless culture reckoning their importance in financial system of the country and it boils down to the regulator to bail them out when in trouble. The best example of this syndrome is Fannie Mae and Freddie Mac. With more players, the concentration risk is mitigated as the market share is distributed and bailout is not a possible affair any more.

On the contrary, the threats are:

To back the wrong horse: A reprehensible selection in terms of giving license can have vandalizing impact on the whole financial system. Financial sector fear the entry of big corporates in banking. On setting up a bank, these corporate have easy access to cheap funds unearthing conflict of interest. For this very reason, the corporates are put at bay when it comes to issuing new banking licenses in USA.

Too many cooks spoil the broth: A market remains attractive for both buyer and seller if both ends meet the value proposition. If majority of banks focus on same customer base, the profitability per customer will plummet and can trade to such low levels that the sector may turn unattractive which triggers consolidation of banks and hence render this whole issuance of licenses a futile exercise.

Also with increased number of banks, RBI’s visibility would reduce that may impede its administering and regulating responsibility.

Market Risk will heighten as the interbank transactions swell to a stratospheric level. Even a single bank failure can threaten the whole system since it is interlinked with other players in the system.Techniques viz. Interest rate sensitivity analysis, Structural liquidity analysis and Fortnightly dynamic Statement analysis need to be inculcated in new banks’ strategy making, in order to measure and mitigate other market risks like liquidity and interest rate risk.

Too many to fail: When there are immoderate number of banks, there can be a situation where banks form groups to provide loans to risky borrowers being aware that they will be bailed out by the regulator in case of any default. An economy cannot afford,notable number of, banks being shut down in short period of time.

Opening up, to allow access to new players, has resulted in tremendous growth of sectors viz. air travel and telecom. Renowned singletons viz.,IL&FS, IFCI, IDFC, IndiaBulls, Reliance Capital, Religare,and Aditya Birla Financial Services are reported to be contemplating about their stint in the banking space.RBI should however look at this opportunity carefully and should see that the financial stability of the country is not jeopardized.Some aspects that need immediate addressing are minimum capital requirements for new banks, promoters’ contribution,minimum and maximum caps on promoter shareholding, foreign shareholding in the new banks, industrial and business conglomerates promoted banks, business model for the new banks and possibility of non-banking financial companies conversion into banks or to promote a bank/banks.

India now is what USA was in 1940’s after which it has taken huge strides to become a superpower of today. Backed up by fundamentally strong banking sector and a competent central bank, India has all the qualities to take the next step forward. Can India Become an Economic Superpower or Will There Be a Monetary Meltdown? The answer will soon be demystified.

This article has been authored by Sunil Choudhary K from NMIMS Mumbai.

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