BackRBI lines up major banking sector reforms
Proposals include consolidation of some large banks, separate licences for specific banking operations
Premium(Ramesh Pathania/ Mint)
India’s central bank is said to be ready to propose radical changes in the structure of the country’s ₹ 77 trillion banking industry, in line with similar reforms introduced in developed countries after the 2008 global financial crisis.
The proposals, expected to be released in a discussion paper in the next two weeks, include consolidation of some large banks to create two-three global ones, the setting up of smaller banks, separate licences for specific banking operations instead of a single universal one, continuous licensing for new banks and conversion of some urban cooperative banks into full-fledged commercial banks, according to persons familiar with the development who did not want to be named.
A Reserve Bank of India (RBI) working group is framing the key points in the discussion paper and is in consultation with financial market committees to apply the final touches, said one of the people cited above.
The suggestions, if implemented, will be India’s first step towards effecting far-reaching reforms and come at a time when RBI has invited companies to apply for banking licences, nine years after the apex bank last issued new licences.
The apex bank announced the final guidelines for new banks on 22 February and set a 1 July deadline for applications. So far, about 25 firms have expressed interest.
In the annual monetary policy for 2013-14 in May, RBI had said it would issue a discussion paper on structural reforms.
Such changes, which include the creation of large banks and expansion of the sector by allowing more lenders with different skill sets to enter, are critical given that Indian banks still lack size when compared with global banks, according to consultants and bankers.
Structural reforms are also important given the inability of the banking system to support a growing economy, evident from the shortage of funds for the private sector, power and infrastructure projects. Besides, Indian banks do not have sufficient penetration in rural markets. Though India has 87 commercial banks, an estimated 40% of the adult population does not have access to banking services.
The country has 87 scheduled commercial banks with deposits of ₹ 71.6 trillion on 31 May. Of this, 26 are public sector banks, which control over 70% of India’s banking sector, 20 are private banks and 41 are foreign banks. Of the total, 41 banks are listed with a total market capitalization of ₹ 9.35 trillion on Tuesday.
“I think it is high time to effect a change in the structure of the banking sector," said Ananda Bhoumik, a senior director at India Ratings and Research, formerly known as Fitch Ratings India.
Creating a global bank
Consolidating some large-sized banks to create a few global ones is a key proposal, said the person cited above.
China had four banks among the global top 10 listed last year in The Banker, the international financial affairs publication. State Bank of India (SBI), India’s largest lender, was ranked 60.
Diwakar Gupta, SBI managing director and chief financial officer, agreed that reforms are badly needed in an economy that’s growing, albeit at a reduced pace than a few years ago.
“(The) real economy is four times bigger than the financial economy and there is a huge need for banking sector reforms to support the growth. There is a need for greater consolidation and penetration. Also, there is a need for greater private sector participation for more efficiency as against the current scenario, where more than 70% of the industry is controlled (by the) public sector," Gupta said.
Even though consolidation has been on RBI’s agenda in the last few years, there have not been many significant mergers in the banking sector. Consolidation has been largely confined to a few mergers in the private sector and among associates of SBI, besides forced marriages involving banks that were at risk with stable entities.
“My take on that (consolidation) will be told very clearly when the RBI comes out with the paper," RBI governor D. Subbarao told PTI in an interview on 9 June, responding to a question on the subject. “It’s a paper about the banking structure for India. We are going to bring it out in the next one month where we will address these issues or at least define the issues for discussion."
Licenses for specific banking tasks
The discussion paper also proposes the introduction of a differentiated licensing policy for domestic and foreign banks, a significant measure for the development of the banking system. Under such a regime, the regulator would give licences to banks to undertake specific banking functions such as wealth management, wholesale banking or retail banking.
Unlike developed markets, India currently has only a universal banking licence system.
“There is a need for differential licensing. If you look at the reasons of why local and community banks have failed, one can see that the whole banking has become formula-driven such as 40% priority sector lending to all category of banks," said Ashvin Parekh, partner (financial services) at Ernst and Young (E&Y) India.
Under current norms, Indian banks need to lend 40% of their loans to agriculture, exports and other weaker sections that comprise this sector.
“Priority sector definitions should also be different. Because the priority sector for banks operating in tier III- VI cities will be different from the priority sector requirements of banks operating in tier I-III," Parekh said.
Such licensing may allow for variations in mandatory requirements such as cash reserve ratio (CRR) and statutory liquidity ratio (SLR), he said, adding this will allow larger banks to focus on tier I-III cities, while small and local area banks can focus on rural customers.
CRR is the portion of deposits that banks have to park with RBI on a fortnightly basis, and is currently pegged at 4%. SLR is the portion of deposits that banks need to mandatorily invest in government bonds. It is currently pegged at 23%.
“(The) broad picture is that we clearly need greater private sector participation of people who can attract and inject a significant amount of equity into business. Differentiated licensing can help to improve private sector participation and efficiency of the banking system," said Bhoumik of India Ratings.
Even though the operations of a majority of the foreign banks operating in India are limited to certain activities such as investment banking, trade finance, wealth management and wholesale banking, RBI has been insisting that they implement priority sector lending requirements on par with other banks.
Many foreign banks have expressed reservations about this.
“We’ve been asked to achieve that (priority sector lending requirement) in five years, which I don’t believe is achievable. But we will do everything we can to try to get there. We have been asked to do that starting 1 April this year... It will be a very, very challenging exercise," Stuart P. Milne, chief executive in India at Hongkong and Shanghai Banking Corp. Ltd, said in an interview on 29 March.
Some of the other foreign banks have also approached RBI for a relaxation of priority sector requirements.
“If a particular bank has a specialized skill in a particular segment and interest to pursue that, why should they be forced to do universal banking? Both universal banking and specialized banking can go hand-in-hand. It is timely that RBI should go for differentiated licensing," said Bhoumik.
The idea of differentiated bank licensing is not new in India. In 2007, RBI issued a technical paper on this, but the plan was a non-starter as the primary concern of the regulator at the time was the slow progress of financial inclusion or access to banking services for the unbanked population.
Easy access and smaller banks
Experts said a continuous bank licensing policy will facilitate the expansion of the sector in a more efficient and less complex manner. Such a policy envisages keeping the window open for companies to apply for a banking licence at any time.
“It is good strategy as it takes the pressure of issuance of banking licence off the regulator and also from the system. One doesn’t need to rush. Anybody who is eligible and prepared can approach the regulator at any time. In most markets, bank licensing is on tap," said Parekh of E&Y India.
The discussion paper, according to the person cited above, also contains proposals on smaller banks such as community banks that will cater to a limited area and operate with a single office. Such banks will be governed by the same rules as larger commercial banks and will mainly offer small-ticket loans and other basic banking services to people in their areas of operation, he added.
India has 30 state and 370 district cooperative banks— most of such banks have failed to deliver due to poor management and capital shortage.
Microfinance companies, another channel for low-income borrowers to bridge the gap with the formal banking system, are only just emerging from a crisis in 2010 that took place after Andhra Pradesh, once the largest market for such companies, promulgated a law severely restricting their operations.
Lessons from global banking
India nationalized 14 large banks in 1969 and another six in 1980. RBI has so far given licences to only a dozen private banks in two phases, including the conversion of a cooperative bank into a commercial bank.
The first round of licences was issued to 10 private sector banks in 1993-94, shortly after economic liberalization under the P.V. Narasimha Rao government. The last time RBI gave a licence was in 2003-04, to Kotak Mahindra Bank Ltd and Yes Bank Ltd.
In the aftermath of the 2008 financial crisis, many nations conducted a major overhaul to strengthen their banking systems.
These included the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act in the US and, in the UK, an independent commission on banking chaired by John Vickers.
In the euro zone, a high-level expert group headed by Erkki Liikanen, governor of the Bank of Finland, drafted a report, Reforming the Structure of EU Banking Sector, in 2012 as part of the region’s efforts to revamp its banking system.
There have been similar efforts in India as well. In 2007, an expert committee headed by former World Bank economist Percy Mistry issued a report on turning Mumbai into an international finance centre.
In 2008, a committee on financial sector reforms headed by Raghuram Rajan mooted a host of reforms to introduce greater efficiency in the Indian financial sector. Rajan is currently chief economic adviser to the Union finance minister.
The recommendations included the sale of small underperforming public sector banks, allowing private well-governed deposit-taking small finance banks and the creation of stronger boards for large public sector banks with more power to outside shareholders.
In March 2013, the Financial Sector Legislative Reforms Commission headed by former justice B.N. Srikrishna submitted its report proposing several reforms in the financial sector.
The commission suggested that financial sector regulators such as the Securities and Exchange Board of India as well as the Insurance Regulatory and Development Authority should be merged into a unified financial agency.
It also recommended that the role of RBI should be restricted to regulating banks and managing monetary policy.
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