RBI ready to let big firms set up banks

RBI ready to let big firms set up banks

Mumbai: The Reserve Bank of India (RBI) is ready to allow big industrial houses to set up banks, but only after it gets the power to supersede boards of banks that are not being run properly. RBI also wants the right to oversee the operations of the promoting company and any affiliates that will have business relationships with the bank.

The central bank will issue guidelines on new banking licences by 31 March, finance minister Pranab Mukherjee said in his budget speech on Monday, but no banking licences will be issued until the Act that governs banking is changed and the regulator gets the powers mentioned above.

“RBI has proposed some amendments in the Banking Regulation Act," Mukherjee said in his budget speech. “I propose to bring suitable legislative amendments in this regard in this session."

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Mukherjee had first announced that the banking regulator would consider giving new banking licences to companies in his last budget.

“The central bank and the finance ministry have reached an understanding that issuance of licences to new players is contingent on changes in the banking law," said a government officer familiar with the development, who did not want to be named considering the sensitivity of the issue.

Currently, RBI does not have the power to dismiss a bank board, but under section 45 of the Banking Regulation Act, 1949, it can force amalgamation or merger of a bank with another, and force a reconstruction of the board to protect the interests of depositors, shareholders and employees.

Typically, such mergers take place after the operations of the concerned bank are frozen by imposing a moratorium, with the approval of the ministry of finance. The moratorium can be in force for a maximum of six months to enable the regulator to form a scheme of amalgamation, although such mergers usually take place within 72 hours, to forestall any panic runs.

In 2004, RBI forced the takeover of the erstwhile Global Trust Bank, which lost money in the stock market, by Oriental Bank of Commerce. The objective was to protect depositors, not shareholders. In the case of a more recent transaction—United Western Bank Ltd’s acquisition by IDBI Bank Ltd in 2006—bids were invited and the interests of shareholders, too, was protected.

The most recent case of such a move involves Bank of Rajasthan Ltd, which was acquired by ICICI Bank Ltd in 2010. Though not forced by RBI, the regulator played a critical role in the merger, ahead of which its nominee on Bank of Rajasthan’s board ran it as the chief executive officer (CEO).

“There has been no precedent of RBI reconstructing a bank board. It can’t take such an extreme step unless there is a systemic crisis or depositors’ interest is threatened," said a banking law expert. “That, too, can be challenged by a firm as such issues can always be a subject to interpretation. A carte blanche to supersede the board can be handy to supervise a bank set up by a corporate house." The expert didn’t want to be named as RBI’s draft guidelines and the proposed amendment to the banking Act are not yet in the public domain.

Currently, RBI approves the appointment of managing directors and executive directors at private banks. There have been rare occasions when the regulator has declined to renew the terms of such officials, but it does not have power to remove non-executive directors on the boards. “Theoretically, RBI can put stringent conditions while approving the CEO’s appointment and keep the top executive on his toes, but this is no substitution for powers to supersede the board," the expert said.

RBI will also need to fine-tune its inspection and supervision, said a banking analyst, who did not want to be named.

“Industrial houses are smarter than the regulator," he said. “If RBI wants to open doors for banking for corporations, the power to supersede boards alone will not be enough to tackle them."

RBI will also insist on candidates having an impeccable record. Those that have been under the scanner of investigative agencies such as the Enforcement Directorate, the Central Bureau of Investigation or the Central Vigilance Commission will not be considered. This may include those being investigated for their role in the allocation of second-generation spectrum for mobile telephony and market irregularities being probed by the Securities and Exchange Board of India.

No small banks

RBI will not allow small non-banking financial companies (NBFCs) and microfinance institutions (MFIs) to set up banks as suggested by Raghuram Rajan, honorary economic adviser to Prime Minister Manmohan Singh, as well as the economic survey, released ahead of the Union budget. The survey made a strong case for two types of banks— those that provide basic banking to fulfil the obligation of financial inclusion, and others that offer a range of services.

Rajan, who is against industrial houses running banks, wants about 20 new, professionally managed small banks with a minimum capital of Rs50 crore.

It appears that RBI is not convinced about the efficacy of small banks and does not favour a differential licensing policy. It would like to have only one type of bank with a reasonably high capital base (higher than Rs300 crore, the benchmark for the last batch of new bank licences in 2003, but lower than the Rs1,000 crore suggested earlier).

Initially, new banks will require a high capital adequacy ratio, which means they won’t be able to grow their asset base fast. Existing Indian banks have a capital adequacy ratio of 9%—for every Rs100 worth of assets, they need to hold a capital of Rs9. If RBI insists on a 15% capital adequacy ratio, banks will need more capital.

According to people familiar with the process both in the finance ministry and RBI, the regulator may issue 8-10 new licences, but no one is sure when this will happen because the central bank will not give its nod till the banking law is amended.

In August, RBI released a discussion paper on new bank licences and had asked for feedback by 30 September. It released a summary of the feedback in December.

All applications will be examined by an external group before RBI considers them.

The paper focused on capital, ownership structure, foreign shareholding norms and the business model of new private banks, but refrained from taking any position on the profile of the new entities that will be given licences to run such banks.

Licences to industrial houses, according to the paper, ensure important sources of capital, management expertise and strategic direction, but a conflict of interest could arise as the firms may misuse the bank for their own needs and restrict credit flow to competitors.

If RBI does allow big industrial houses to enter banking, corporations will come back to this sector after a gap of three decades. The government first nationalized commercial banks run by industrial houses in 1969 to shift the focus from “class" banking to “mass" banking under former prime minister Indira Gandhi. In 1980, another set of banks—including Syndicate Bank and Corporation Bank—was nationalized.

In the early 1990s, RBI opened the doors for private firms to set up banks. Four of the first set of 10 didn’t survive. In 2003, two more banks were approved—Kotak Mahindra Bank Ltd and Yes Bank Ltd—and both have done well.