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Capital is one of the major concerns facing the banking system.
Capital is one of the major concerns facing the banking system.

The new themes evolving in the banking system

The regulator whose key task is to regulate banking system with keen interest in deposit holder protection and system stability will react to disruption or new developments

This article attempts to evaluate the new themes which may disrupt and perhaps reconstruct the banking system in the next few years. At the core, we assume that a few underlying premises are valid for the banking system throughout the globe and then examine the themes in the Indian context. We believe that in developed and mature markets, the industry develops the disruptive themes. This would be particularly true in large market economies. In the developing economies, it would be led by the policymakers who in most cases are key shareholders and also the managers of the system. The regulator whose key task is to regulate the system with a keen interest in deposit holder protection and system stability will react to the disruption or new developments. The Indian banking regulator, however, has been playing a larger role. We see all the substantial reforms, be it in the corporate governance area or a structure of the banking system, conceived and developed by this stakeholder.

In the conception and development process normally a thinker or a think tank may adopt a disruptive approach with a very clear idea of reconstruction, once the existing system is disrupted. Sometimes he may not have that clarity but may leave the work of reconstruction to the industry. If we now look at some of the new themes which are coming out in the system, one wonders which of the two approaches our present attempt falls into. We need to have some clarity and more discussion around this.

The first such theme is the introduction of differentiated banking licences. We acknowledge that the Indian banking system is largely dominated by universal banking, which is ownership agnostic i.e., public, private and co-operative sectors have a universal banking approach to their banking. It is characterised by highly artificial pricing of liability and asset products and is dramatically cross-subsidized. In differentiated banking, there is very little room for cross-subsidization. This structure which emphasizes banking with limited products such as payments banking or small banking will have very little legroom for the players to compete with the universal bankers who, at least for the present, dominate the system. Added to this is the inclusion responsibility, which would make the viability of such entities more difficult. Inclusion itself is a non-viable business as of now and players with shallow pockets may find it very difficult to work with. Then again the introduction of telecom and retail companies would require a much higher order of banking discipline that the regulator will have to bring about.

There is also a new theme which is being proposed which would introduce a new order of banking. We are now emphasizing separating the ownership of the banking system from the management. This is a very commendable initiative but its ramifications have to be well evaluated. If we accept the premise that public sector banking enjoys the confidence of the deposit holders arising out of the implicit sovereign guarantee, then its withdrawal would have larger implications in the deposit base of the entities. It would certainly bring about a very level playing field for private sector banking but will have its own cost and consequences.

Capital is also one of the major concerns facing the banking system. Between the stakeholders, namely the government and the regulator, there is a need for clarity on the size of capital required by the banking system and more importantly where it is going to come from. There has been a sizable erosion of capital arising out of poor economy performance and corporate governance in the banking system.

Then again we have to fund our infrastructure requirements and also fund our financial inclusion and Basel III requirements. The new reform to allow the banking system to float long-term debt for acquiring long-term infrastructure assets is very significant and radical in its proportion. A very high order of self-discipline and regulatory oversight will be required in this regard.

In all the themes which will have an impact on the banking system mentioned above, which are largely led by the regulator’s office, there is likely to be an industry response which could be very interesting to study. In most sectors of the economy we find that when a new opportunity opens up several entrepreneurs will seek an entry.

In most cases, the aspect of fit and proper is normally left to the market to determine. In manufacturing or in the service sector, if there are failures, then those are accepted as a way of growth and the world moves on. The banking sector is a huge exception.

There is perhaps very little room for experimentation. This places a much larger task on the regulator and of course finally the government (thereby the tax payers) who end up paying for the experimentation. We have however followed a very balanced and conservative approach to banking. In this backdrop, we may therefore assume that there is a larger reconstruction programme which is aiming at keeping the system very stable and introducing the reforms with an end state in mind.

(Views are personal.)

Ashvin Parekh is managing partner of Ashvin Parekh Advisory Services Llp.

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