After lobbying hard with the government for a piece of lucrative banking business, most industrial houses developed cold feet as they did not see any value creation within the RBI framework and those who had applied could not pass through the regulator’s intense scrutiny. Photo: Indranil Bhoumik/Mint
After lobbying hard with the government for a piece of lucrative banking business, most industrial houses developed cold feet as they did not see any value creation within the RBI framework and those who had applied could not pass through the regulator’s intense scrutiny. Photo: Indranil Bhoumik/Mint

New bank licences: Why RBI chose only two banks

RBI's decision to give permits to only two of the 25 applicants is momentous in the history of policymaking in India

My last week’s column on differentiated licensing evoked strong response from stakeholders. A couple of entities that had applied for a bank permit but did not get it have expressed deep disappointment with the Reserve Bank of India’s (RBI) ultra-conservatism while a few analysts said opening a window for limited licences cannot justify the regulator’s reluctance to welcome not more than two applicants.

Incidentally, unlike in 2001, when RBI had made it clear that “the number of licences to be issued in the next three years may be restricted to two or three of the best...proposals", it was silent this time on how many new banks it wanted in the system. It merely said the permits would be issued on a “very selective basis" and it might not be in a position to give licences to all applications that meet the eligibility criteria. I don’t know how many actually met the eligibility criteria but the regulator’s decision to give permits to only two of the 25 applicants—and none to an industrial house—is momentous in the history of policymaking in India.

Former deputy governor Anand Sinha once said, “We are painfully aware of the pitfalls (of industrial houses owning banks), but we will make sure that regulations are not subverted," and he stuck to his words.

The regulator’s reluctance to give licences to corporations is well-known but the way it has managed to stick to its stance despite agreeing to open the doors to companies under pressure from the government is remarkable. The credit goes to former RBI governor D. Subbarao as well as current one, Raghuram Rajan—Subbarao for drafting the guidelines in such a way that not too many corporations were excited to apply for a banking licence, and Rajan for keeping them out from the list of successful candidates. The reluctance stems from the fact that industrial houses, if allowed to enter the business of banking, can play mischief by using public money for their own benefit and denying money to the competition.

After former finance minister Pranab Mukherjee announced in February 2010 that RBI would open up the sector for a new set of private firms, the regulator first released a discussion paper in August 2010 and followed it up with draft guidelines on new bank licensing in August 2011 and final guidelines in January 2013. The final norms removed the provision, outlined in the draft norms, that corporate entities earning at least 10% of their revenues from broking or real estate business would not be eligible to apply for a permit but stipulated that bank promoters’ business culture should not be misaligned with the banking model. “Their business should not potentially put the bank and the banking system at risk on account of group activities such as those which are speculative in nature or subject to high asset price volatility," it said.

It also emphasised on the promoter groups’ sound credentials and integrity, financial health, successful track record of running a business for at least 10 years and, most importantly, they should never be under the scanner of any regulator, enforcement and investigative agencies. To own a bank, they also needed to set up wholly-owned non-operative financial holding companies (NOFHCs), to be registered as a non-banking financial company with RBI. It was also made clear that the NOFHC and the bank should not have any exposure to the promoter group; the bank cannot invest in the equity or debt capital instruments of any financial entities held by NOFHC; and the board of the bank should have a majority of independent directors. On top of that, the promoters were to list their shares on stock exchanges within three years of starting operations and bring down stake to 15% in 12 years.

The tight guidelines are only one part of the story. RBI also pushed through an amendment to banking laws in Parliament to strengthen its regulatory powers. Till recently, it had the power to remove a director of a banking company but the amendment has empowered it to supersede any bank board that acts in rogue fashion, and appoint an administrator for managing the bank for up to one year. Besides, RBI can also seek information from and inspect, if required, associated companies of the promoter of a bank.

Well after two decades of bank nationalization, when RBI opened the doors for a set of new banks in January 1993, it had received 113 applications, many from large industrial houses. But this time around only three industrial houses applied—Aditya Birla Nuvo Ltd, Bajaj FinServ Ltd, and Reliance Capital Ltd— even though the universe of Indian corporations has expanded manifold in the past two decades and opportunities in the banking space are enormous with a burgeoning middle class with high disposable income and a predominantly young population. The Mahindra and Mahindra group did not apply for a permit while the Tatas withdrew its application. Clearly, after lobbying hard with the government for a piece of lucrative banking business, most industrial houses developed cold feet as they did not see any value creation within the RBI framework and those who had applied could not pass through the regulator’s intense scrutiny.

That’s about the process of elimination. What about the selection? It’s not easy to find fault with the chosen two. Bandhan Financial Services Pvt. Ltd is a successful microfinance institution based in eastern India, a playing field of shadow banks. IDFC Ltd is a different story. Set up by the government to cater of infrastructure financing, its business model will find it difficult to survive unless it is converted into a bank. Had RBI not been meticulous in its choice, it would have run the risk of being taken to court by any of the unsuccessful applicants.

Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint’s deputy managing editor in Mumbai. He is also the author of A Bank for the Buck, a book on HDFC Bank. Email your comments to bankerstrust@livemint.com

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