AN INSIGHT TO BANKING LICENSES : IS IT A WORTH IDEA?

 

Is New Banking Licenses by RBI a good idea?

Indian economy is Counted as an attractive destination for investment, there is robust demand for banking services in India. India has huge and untapped potential for banks fueled by growing demand for affordable and high return savings products. The key objective of broadening and deepening reach of banking services in India has prompted RBI to consider giving fresh banking licenses after 10 years. RBI recently announced its guidelines for licensing of new banks which clearly indicates that the RBI’s preference is to have larger banks. As entry barrier would be high, only serious players will enter into the banking sector.The corporate businesses, where the promoter shareholding is less than 49%, could effectively qualify for acquiring the license. But the PSU companies are not qualified, as by definition, they have more than 51% promoter holding. So, the PSU companies are not in the race and one should not expect a government owned bank to come up. The guidelines stipulate that the promoter shareholding of the holding company should have to be brought down to 40% and the bank must get listed within 3 years from the date of commencement of the bank. Now, here is the catch. Suppose, the new bank starts with the minimum paid-up capital of INR 500 crores; as per this guideline, the promoter shareholding has to be brought down to 40% (which is INR 200 crores) within 3 years. So, the return that the promoter would get with this reduced holding after 3 years would also decrease in comparison to the earlier situation, when the promoter had INR 500 crores. Thus, it is very likely that the new banks may start their business with starting capital greater than INR 500 crores. One of the guidelines states that the individual voting rights is restricted to 10% and the companies belonging to the promoters must hold at least 51% of the total voting equity shares. The implication is that a big parent unlisted company’s holding must be restricted to only 10%.

The RBI guidelines may implicitly restrict some companies to enter into the banking sector. FDI in new banks would be capped at 49% of equity for initial 5 years and may be extended up to 74% thereafter, as per the policy. The bank must open at least 25% of its branches in rural areas having population greater than or equal to 10,000. Bank should also operate on Core Banking Solutions (CBS) from the start and be equipped with all modern infrastructural facilities. The potential entrants can be TATA Capital, Reliance Capital, L&T Finance, Shriram Transport Finance (STFC), Mahindra & Mahindra Financial Services (MMFS), Bajaj Finserv, etc.Since a large part of Indian population is not served directly by banks, mainly rural population, the banks will have to come up with several schemes to lure the customers and thus, create differentiation. The banks will have to be patient enough in the rural areas as the profit from these branches grow very slowly. One more point to be noted is that once the new banks come into the business, they can’t sell it off in the next few years. It means that exit barrier is also high same as the entry barrier. Thus, the new banking license is in sync with the reform process carried out by the government. But, it must be ensured that the entire process is finished off effectively and within time. The new entry of banks would no doubt intensify the competition of the banking sector but at the same time, it would also exploit the untapped opportunities. This would help the government to achieve their aim of financial inclusion.

 

 

The new banking licenses are undoubtedly likely to encounter challenges of geographical coverage, insufficient infrastructure and inadequate technology. However certain regulations have gathered opponents more than proponents.

On the contrary

The opponents of reform allowing industrial houses to enter banking space have argued of conflict of interest between corporate interest and banking interest. It has been observed that regulators in other countries also do not allow corporate to set up banks and if they do there are restrictions on ownership and voting rights. The flaw in the reform is possibility of increase in risky loans from lending to related firms. If the loans backfire it could trigger a huge crisis. But on the flip side India can leverage upon deep pockets of corporate and bring new technologies to extend financial inclusion to underserved markets.Rural branch coverage compulsion can be a bottle neck as it is difficult to service those in remote areas and also be profitable. Achieving priority sector lending target of 40% also seems unrealistic considering existing banks failure to meet the target. But constraints give way to innovations. FMCG companies have long back understood the dynamics of the rural segment and have been making maximum money from bottom of the pyramid. But careful thought and strategy will enable banks to seek niches in this segment of population and make a difference.

RBI’s Objective

RBI along government have taken major steps of nationalization of banks, priority sector lending norm, emphasis on mobile banking in the past to bring un-banked population under the umbrella of banking services. Being bank of banks RBI has responsibility of safeguarding the public interest. It has come up with tight guidelines to ensure only responsible people enter the banking space. The new entity is required to set up a wholly-owned Non-Operative Financial Holding Company (NOFHC). This will protect banking operation from other businesses of group. The high quality regulation can ensure liquidity and profitability of banks. Kotak Mahidra bank is the best example for the same.

Road Ahead

Overall guidelines by RBI seem to be a welcome development, paving way for more capital and more players in the sector. For the industry dominated by state lenders new banking license move is intended to increase competition and efficiency in the sector. Although challenges of risk management, rising NPAs, capital adequacy ratio compliance and other stringent norms remain, the strong performance of banking sector over past few years showcases vast opportunities.