Entry of New Banks in the Private Sector, a discussion paper released by the Reserve Bank of India (RBI), contains an interesting thought. The paper suggests: “As an intermediate step, industrial and business houses could be allowed to take over Regional Rural Banks (RRBs), before considering allowing them to set up banks.” This, according to RBI, would give these houses an opportunity to prove their suitability for promoting banks.
As the prime driver for granting new bank licences is neither competitiveness nor efficiency enhancement—as was the logic earlier—but financial inclusion, the take over of RRBs is perhaps the only suggestion in the discussion that has enormous potential.
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No matter how many new licences are given and who get these, it is not going to have any serious impact on the process of financial inclusion. Indeed, the licences given in the first flush of liberalization haven’t changed the level of financial intermediation in the economy.
More than liberalization of the financial sector by allowing new private players, what is required today is the structural reorganization of the banking sector. Once RRBs are reformed, there will be a systemic change in the banking landscape of the country.
The size and spread of RRBs is not too well known. It may come as a surprise to many that there are 84 RRBs with almost 15,500 branches spread over 600 districts in almost all states.
To put this in perspective, RRBs have one-third the branch strength of all the Scheduled Commercial Banks (SCBs); the 96 SCBs have a combined network of 53,000 branches. Of the 84 RRBs, there are three that have more than 500 branches each. At least a dozen have 250-500 branches, and 39 have 100-250 branches.
Over the last three years or so, RBI has done excellent nuts-and-bolts work on RRBs. From almost all of them being in the red in the previous decade, all but three of the 84 are now profitable.
The process of consolidation through amalgamation, and recapitalization of Rs1,800 crore, is now almost complete. In a year, all RRBs will get major technological upgrades as they migrate to a core banking solution platform. Operating in a fairly deregulated environment, RRBs are now in an ideal position for structural change.
The only problem now is their ownership structure. Set up in 1976 under the Regional Rural Banks Act, RRBs are owned by the Union government, the state government and the sponsor bank, which hold 50, 15 and 35% shares, respectively.
But RRBs still lack stakeholders. None of the three promoters takes performance ownership of these institutions. The boards of RRBs are filled with ex-officio members of the shareholders, rarely with regard to competencies.
Most sponsor banks, which fully control the management of RRBs, depute their dispensable officers to these institutions as chairmen, who in turn treat it as a punishment posting. In addition, most state finance ministers aren’t even aware of how many branches RRBs in their states have. As for the Centre, RRBs are too dispersed and their operations too small to deserve its attention.
Given this state of affairs, RRBs are ready for a big bang change. The way to it would be to convert RRBs into microfinance institutions (MFIs). A time-bound road map must be formulated for this conversion.
This done, any interested player qualified under defined criteria, not just industrial groups or corporate bodies, should be allowed to take over RRBs and convert these into MFIs. Even the existing sponsor banks should be allowed to buy out the Central and state government stakes and run RRBs on professional lines. All this will need a legislative change, but it will be worth the effort.
The conversion to MFIs will give RRBs a distinct business model and space wherein they wouldn’t have to compete with the commercial banks at the outset.
This will also mean creating MFIs that will be able to accept deposits, giving the new entities a huge advantage over existing MFIs by reducing cost of funds. Instead of borrowing from banks at 10-12%, they would be able to gather deposits at 3-6%. Already, SKS Microfinance has shown that even without a deposit franchise, an MFI can raise enough equity in the market.
As far as buyers are concerned, it is a great business opportunity—a network in the heart of rural India, seen as a big honey pot; very cheap valuation; and hence the opportunity to build value and make some serious money.
Operationally, the first to go on the block should be the 50% shareholding of the Union government. This acquired, the new entity should be allowed to buy out the state government and the sponsor banks. This could be followed by going public within a stipulated time period. It is this that will drive the market appetite for RRBs, and provide immediate impetus to financial inclusion and agricultural credit in a profitable manner, not as a social obligation.
Haseeb A. Drabu is chairman and chief executive of Jammu and Kashmir Bank. He writes on monetary and macroeconomic matters from the perspective of policy and practice. The views are his own and don’t necessarily reflect the views of the organization he works for. Comment at firstname.lastname@example.org