This column had recently commented on the Reserve Bank of India’s (RBI) insistence on amendments to the Banking Regulation Act as a precondition to issue of bank licences. Little did the author expect that the whole issue will snowball into a full-blown slugfest between RBI and the government so quickly.
By now it has been established that the ostensible reason for more bank licences as expressed two budgets ago—more financial inclusion—is arrant nonsense. This author had, in 2006, done an exercise in banking market concentration around the world, which showed that India was the third-most fragmented market. Some water has flowed under Mint Street since then—with the disappearance of the likes of Centurion and Bank of Rajasthan—but the essential point remains the same: if such levels of competition have not helped the cause of financial inclusion, a few more licences will not accomplish that.
Some of us may recollect that the licences given out in 1993 had a condition that banks’ head offices should be outside of the metros, thereby ensuring a better geographical spread. The industry conveniently interpreted head office to mean a registered office, which was set up in places like Vadodara, with corporate offices in Mumbai. Lesson: inconveniences will be adroitly circumvented.
RBI had added to the confusion by suggesting that since 60% of the country’s population is unbanked, this is not the time for consolidation but more competition. However, they simultaneously add that free entry should co-exist with free exit, and hence their demand for the power to supersede bank boards.
The government’s loose assurance that the Act will be amended during the time it takes to finally issue the licences is, charitably speaking, disingenuous. RBI is fully aware of how slowly legislation has moved (or not moved) in Parliament; this specific set of amendments itself has been pending for several years, and contains a whole host of contentious clauses on which political consensus is a chimera. Additionally, RBI is right in not succumbing to the government’s contention that existing rules and regulations give sufficient powers to the central bank. They do not, and more importantly, RBI shrewdly understands the difference between laws and rules, and what comes first.
Actually, disagreement over bank licences is an old story; it’s just that we deluded ourselves into thinking that things have changed on this front. RBI has always been fundamentally uncomfortable with the proliferation of more entities to supervise, in such a delicate sector. The external manifestation could have changed a bit. For example, it is a tad more comfortable with business groups owning a bank. But its basic concern on disciplining rogue bankers has not reduced, and rightly so.
Moreover, their experience with banks from 1993 onwards has been spotty at best. There were quite a few like Centurion, Bank of Punjab, and Bank of Rajasthan that were revived from the brink, and an outright failure in Global Trust Bank (some of these were old banks, though). The last will not be forgotten in a hurry. Allegedly, in the absence of sweeping powers, RBI could not take sufficient preventive action on Global Trust due to political pressures, and had to reportedly wait for a regime change before swooping down on it. A perennially uneasy calm prevails within the group of south India-based old banks, regarding either control or operational weaknesses.
The ungainly haste shown by the government on this matter is simply a result of the realization that the 2014 general elections are drawing near. It understands that it will take seven-eight months to issue the first licence from the point the guidelines are finalised, and there lies the danger of slipping on the timeline. The purpose of licences is twofold: to show another reform measure to the world and to ensure that some business groups, which are extraordinarily keen on a banking business, get satisfied. The former is humbug—the rapid waxing and waning exuberance post announcement on retail and airline foreign direct investment should amply demonstrate that the public is quick to appreciate what real reforms are, and bank licences are not one of them.
RBI governor D. Subbarao should stand his ground, taking a cue from this (probably exaggerated) story. A former finance minister had called up the then RBI governor, directing him to reduce interest rates and ignore inflationary outcome. The governor told him politely to take a walk. The finance minister asked him, “Do you know who I am?” To that, the governor said, “Yes, that’s precisely why I am asking you to stay away.” The alternative, placatory way to convince the government is to emphasize that they, and not RBI, will have to bear the consequences of a bank failure, like credibility and reputational risk. And of course, to comprehensively bust the myth that more banks will mean more financial inclusion.
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.