Reserve Bank of India’s (RBI) recent draft guidelines on issuing new bank licences have generated significant excitement among companies that have been waiting for RBI’s move on the subject. The step will encourage competition, which will result in lower interest rates and customized loan and deposit products for the consumer. Considering that banking penetration of loans and deposits in India is extremely low—mortgage as a percentage of the gross domestic product (GDP) in India was 7% compared with an average of 22.5% in other developing countries and 80% in the US (2008 statistics)—more competition and greater financial inclusion are worthy policy objectives to pursue while managing the inherent risk that goes with such a change in licensing regime.
There has been much debate on allowing companies to start banking services. The proponents and detractors both have merits to their argument. Hence, RBI and the finance ministry have been mulling over this for quite some time. I will discuss how this will affect common loan borrowers in India, especially in case of home, personal and auto loans. If the new regulation is implemented properly then we will have new banks in India with more customer-focused, dynamic and innovative services.
Effect on auto and consumer loan
Innovation: New banking entrants will have the appetite and capability to take innovation to a new level in product design and can also be expected to bring a fresh customer focused approach to banking. We can expect to see new financial products in home and auto loan segments.
We have seen how Manappuram Finance Ltd and Muthoot Finance Ltd built their portfolio solely by offering gold loans to consumers as an alternative to traditional moneylenders. This product from non-banking financial companies (NBFCs) took the market by storm and today every bank in India, including the largest private and government-owned banks, offer gold loans at an attractive interest rates of 12-15% as an alternative to personal loans in the 15-20% interest rate range. This gold loan innovation would not have come about if NBFCs hadn’t shown the way. Knowing that their source of funds (as NBFCs) was higher than those of banks because of which they could never hope to offer 8% home loans like the banks, they innovated in a product category (gold loans) for which they knew they could charge more than 12% and yet find demand at a profit. If these NBFCs and qualified corporate houses are provided full banking licences they could innovate with home, car and personal loans in the same way they did with gold loans and the winner in this competition would be the intelligent Indian consumer.
Axis Bank Ltd’s 0% prepayment fee home loan, Housing Development Finance Corp. Ltd’s three-five-year fixed home loan, ICICI Bank Ltd’s two-year fixed home loan are all examples of product innovation that make it easier for borrowers to refinance and manage their exposure to interest rate risk albeit for a portion of the loan tenor. Increased competition will result in more such products and optimized risk management schemes tailored to individual borrower risk profile and requirements.
Lower interest rate: The second effect will be on the interest rate. The market will have more competition among banks. This will again be good for the borrower as many banks may offer lower rates on cars or homes. There will be more innovative partnerships with car manufacturers, online financial services, dealers, real estate developers and sellers to provide a better value proposition for the customers.
Better festival deals: Consumers can also expect to see better and increased number of deals during festivals for car and consumer loans.
More choice: Finally, borrowers will have more choices. You will be able to choose from a variety of options ranging from floating rates, fixed rates or a combination.
The risk outlined by many economists and bankers is that the companies may create banking structures in a manner that they lend their own holdings and projects without implementing enough risk control mechanisms. This is a valid concern. If companies focus more on lending their own ventures instead of servicing people, the advantage of such companies coming into the banking sector may not be beneficial for common borrowers.
The main deterrent to this move of increasing competition is that banking services are very different from typical company services. The cost of failure is too high and failure of one entity can have a cascading effect on other banks. Effective monitoring and streamlining will be an immense challenge for RBI with the increase in numbers of new companies but it will have a positive effect on the consumer if the risk is managed right.
However, allowing private firms to be a part of the banking sector could be a great policy initiative by RBI if it also implements strong measures to check misuse of the banking licence. It is a step that can only help borrowers.
Adhil Shetty is CEO, BankBazaar.com.
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