The recommendations of the committee for the financial sector reforms, that were recently put up for public comment, seek to fundamentally alter the landscape of the Indian banking sector.
For one, they include greater autonomy for public sector banks (PSBs), unshackling them from the fetters of a multitude of “public sector” administrative regulators, allowing proportional representation of various stockholders—public and private—in truly empowered PSB boards.
The committee advocates greater liberty for all banks in general. Licensing of branches and automated teller machines by the Reserve bank of India (RBI) should cease and these should become tradable between banks. Doors should be opened for smaller banks to start, while banks that become undercapitalized according to the new norms should be promptly shut down. The monopoly of banks over access to the payment system and cheque writing facility should decline in step with its obligations to provide cheap funds to the government, priority sector and public sector entities.
Given the increasing range of services provided by financial firms, the committee envisages the financial holding company structure with subsidiaries ranging across various fields—banking and non-banking—as the model for the future.
What would be the broad impact on India’s banks if these suggestions are implemented?
First, the banking sector would become largely “ownership neutral”. PSBs, domestic private sector banks and foreign banks would become largely indistinguishable in their operations and business models. Further, the distinction between banks and non-banking financial companies (NBFCs) would become far less watertight and areas of competition will be determined by the functions rather than forms of the competing institutions.
As the financial sector develops in India, the traditional boundaries between banks and NBFCs become fuzzy. Banks now sell insurance and mutual funds and provide portfolio and corporate treasury advisory services while NBFCs accept term deposits and provide loans.
To avoid perverse incentives and regulatory arbitrage, it is important that institutions serving essentially the same function face the same set of regulations whether they have a banking licence or not. For instance, secured creditors such as banks and NBFCs should have the same status with regard to the SRFAESI Act or debt recovery tribunals, which is not currently the case.
Regulations should deal with functions, not historical labelling of institutions. This is true not just for banks and NBFCs but across and within various sectors of the Indian financial landscape.
Going by the relative performance of different bank groups in recent years, PSBs have fared no worse than other groups. However, the future looks different.