Mumbai: Issuing licences to new banks should be a continuous rather than an intermittent process to make the sector more competitive, the Reserve Bank of India (RBI) has suggested in a discussion paper on ways for the Indian banking system to grow.
“As India grows, it is hard to imagine that all the valuable financial ideas will only originate in existing institutions,” the discussion paper said, supporting the case for new entrants on a continuous basis.
Although new permits could be on tap, getting one will not be easy.
“Stringent entry norms, especially regarding capital and related buffers to be prescribed by the regulator will ensure that only eligible and deserving entities will be able to enter the fray,” said the paper, titled Banking Structure in India—The Way Forward.
Continuous authorization of new banks is not new in India. All foreign banks enter the country through this process, although domestic aspirants must wait for the central bank to open its licensing window once in a few years.
The stop-and-go licensing policy leads to a “frenzied” response from a large number of competing aspirants and promotes “rent-seeking”, the paper said.
“By giving licences once in a decade, some kind of artificial scarcity gets created, as if some kind of rationing is going on, and it indeed attracts all kinds of frenzied activities,” said Naresh Makhijani, a partner at consulting firm KPMG in India. “However, if it is a free flow, not too much of an undercurrent is visible and people who are genuinely interested, and are ready to be banks, can apply. This is healthy for the system.”
While a competitive financial market does not necessarily require a large number of institutions, the “market must be contestable”, prices should be market-driven competitive outcomes, and there should be “liberal entry and exit”, the central bank said in the discussion paper.
A gradual increase in the number of banks will also not strain the existing banking system in terms of business and human resources, which could be the case when permits are issued in bulk.
After the nationalization of banks in 1969, RBI first allowed private banks to set up shop in 1993. India’s largest private bank ICICI Bank Ltd and most valuable bank HDFC Bank Ltd started at that time. The last permits for new banks were issued in 2004, when Yes Bank Ltd and Kotak Mahindra Bank Ltd were established.
The new banks poached people from existing state-run banks, creating a vacuum in trained manpower and strained their leadership pipeline.
The floor is again open and a new set of banks is expected to come up before the end of the fiscal to March. RBI has accepted applications from 26 aspirants, including Tata Sons Ltd, Reliance Capital Ltd and Aditya Birla Nuvo.
Besides, there’s a case for converting urban cooperative banks into full-fledged commercial banks so more people can get access to banking even as niche banks and differentiated licensing for specialized banks could be the way forward, it said.
“It is true that differential licences help cater to the niche market, including rural markets, but the mandatory requirements of priority sector lending, CRR (cash reserve ratio) and SLR (statutory liquidity ratio) should be different for these banks since they are not free to do all kinds of business like a normal bank can,” said Ashwin Parekh, senior expert advisor at consulting firm EY, earlier known as Ernst and Young.
Although consolidation is welcome, it should not be forced on banks to attain a global size. “Global size is not imminent,” the RBI discussion paper said, favouring a more “measured approach”.
State Bank of India, the country’s largest lender, ranks 38th and ICICI Bank ranks 99th among top global banks. RBI governor D. Subbarao said in 2011 that even after reasonable consolidation, no Indian bank can rise into the top 10.
“In the international banking arena, size, innovation, efficiency and best standards of customer service alone matter,” the discussion paper said. “There is no substitute for innovation to survive and lead in the new-age banking.”
India, on the other hand, faces a more fundamental challenge of financial inclusion. According to the World Bank, India has around 3.5 automated teller machines and less than seven bank branches per 100,000 people, compared with 30 branches and 90 cash machines for the same number of people in developed countries.
“There is merit in the argument that consolidation will not make a global top bank in terms of size. However, consolidation allows a bank to hedge its portfolio better, gives the large entity more play to meet the credit need of domestic companies as well as gives enough reach and balance sheet strength to engage in financial inclusion in a meaningful manner,” said EY’s Parekh. “A small- or medium-sized bank may not be suitable enough for financial inclusion because it is still not a financially viable business.”
A financial holding company is the preferred model under which banking should take place and all foreign banks should ideally incorporate in the country, the paper said.
It is better to enable public sector banks to improve their performance while promoting private sector banks, the discussion paper said.
To address the issue of capitalizing public sector banks, a host of options, including issuing non-voting right shares and divestment remains open to the government.
The banking structure in India is likely to consist of four tiers. The first tier will have three or four large Indian banks with domestic and international presence along with branches of foreign banks in India.
The second tier is likely to consist of several mid-sized banking institutions, including niche banks with economy-wide presence.
The third tier may encompass old private sector banks, regional rural banks, and multi-state urban cooperative banks.
The fourth tier may include many small, privately owned local banks and cooperative banks, according to the discussion paper.
Comments on the paper have to be submitted to the central bank by 30 September.