In October 2011, when India’s banking regulator freed the interest rates on savings bank deposits, it completed a process which had started two decades back—allowing the market to decide on the rates of loans and deposits in the Indian banking system. However, the “free market” has not benefited the customers—both the borrowers and the depositors—as much as it should have because of an extremely restrictive entry policy in the banking space. There is an inherent contradiction in the coexistence of a free market and a repressive banking system. Reserve Bank of India (RBI) governor Raghuram Rajan seems to be determined to address this.
Till 2014, in 67 years since India’s Independence, we had got 13 new banks in three phases and all have not survived. The first set of 10 banks, including the conversion of a cooperative bank, came in 1993. A decade later, two more were given licences. And, in November 2013, the Bharatiya Mahila Bank was born, the lone government-owned entity among the new banks.
The scene has changed dramatically since August 2015 when Bandhan Bank Ltd was launched, the first instance of a microfinance institution (MFI) converting itself into a bank. IDFC Bank Ltd followed two months later. Around that time, RBI gave conditional licences to 10 small finance banks (one of them is already operational) and 11 payments banks (one has dropped out of the race). In April, RBI expressed its intention to allow wholesale banks and custodian banks to come up and finally, last week, it released draft guidelines for ‘on-tap’ licensing of private sector universal banks.
Clearly, RBI is ready to say goodbye to a repressive financial system. I presume ‘on-tap’ licensing will ensure that every ‘fit and proper’ candidate is allowed to float a bank. If indeed that happens, it will revolutionize the financial system in Asia’s third largest economy. As competition intensifies, the informal cartelization of banks to deny benefits of free savings rate will break and loan rates too will come down. Apart from this, there will be a couple of other interesting fallouts of a liberal entry regime in the banking space.
India’s government-owned banks, which account for about 70% of assets, will lose their market share. A pile of bad loans, lack of capital and inefficient board and top management in some cases, among other things, will shrink business opportunities for them. Which is why both the government as well as the banking regulator have been pushing for consolidation among public sector banks. Interestingly, many foreign banks too have lost their way in India.
Finally, it is now clear that we are moving into a bank-led financial system. Eight of the 10 licences for small finance banks were given to MFIs. Barring a couple, all large MFIs will transform into banks. The draft guidelines for ‘on-tap’ universal bank licensing will encourage large non-banking financial companies (NBFCs) to convert themselves into banks. Relatively small MFIs and NBFCs will continue in different niches but, overall, the banks will dominate the financial system and the regulatory arbitrage between banks and non-banks will end.
The deadline for suggestions and comments on the draft norms expire on 30 June, but no time-frame has been given for the final guidelines. While analysts and prospective licence-seekers are busy dissecting the draft guidelines, I am tempted to raise a few issues.
The idea of allowing individuals and professionals with 10 years of banking experience to promote banks and keeping large business houses out of it (they can invest in the banks up to 9.99%) are welcome, but what is so sacrosanct about resident Indians and NBFCs controlled by residents? In a capital-starved country, why can’t RBI let non-resident Indians and firms controlled by foreigners float banks? They can bring in capital, skill, technology, modern products and processes and innovations. As long as ownership is separated from the management and a bank is not allowed to have any exposure to its promoters and major shareholders, there is no harm in relaxing this norm.
Second, in the final guidelines, the regulator must indicate a time-frame for a bank licence application and RBI response. Without this, ‘on-tap’ licence will lose its meaning. I presume, while opening the window for ‘on-tap’ licensing, RBI does not have a figure in mind. If this is true, every ‘fit and proper’ applicant should get a licence.
Finally, every time RBI opens the door for banking licence, why does it need to refer the applications to an external committee? For the first set of new banks, in the early 1990s, a panel led by economist-bureaucrat Sharad Marathe, the first chairman of the erstwhile Industrial Development Bank of India, scrutinized 113 applications, many from large industrial houses. For the second set, early this century, a three-member committee, comprising former RBI governor I.G. Patel, former comptroller and auditor general of India C.G. Somiah and former State Bank of India chairman Dipankar Basu, sifted through the applications. For the latest two universal banks, a panel of former RBI governor Bimal Jalan, former Securities and Exchange Board of India chairman C.B. Bhave, former RBI deputy governor Usha Thorat and RBI board member Nachiket Mor made the recommendations based on 26 applications.
The draft guidelines for ‘on-tap’ licences say a standing external advisory committee will be set up for this purpose. Typically, the committee submits its recommendations to RBI for consideration and the decision to issue an in-principle approval for a bank is taken by the banking regulator. In the past, RBI has shot down a few names shortlisted by the external committee but never added any name on its own. That’s fine, but why does it need an external panel to lend credibility to the process? I am sure it’s not afraid of being accountable. When a foreign bank seeks a licence to operate in India, RBI itself takes the call. Wiser with giving 35 banking licences in the past two-and-a-half decades, the 81-year-old banking regulator can take the onus on itself to pick the right candidates.
