HT PAREKH FINANCE COLUMN

On-tap Bank Licences

To What Purpose?
T T Ram Mohan

Critically evaluating the draft

guidelines for on-tap bank
licences put up by the Reserve
Bank of India, it is argued that
Indias banking system is already
sufficiently competitive, and there
appear to be few who would be
willing to enter the banking
business. Entry of newer players,
especially those with corporate
backing, cannot be the priority at
the moment. The priority over
the next two or three years has
to be the resolution of the
non-performing assets problem
and strengthening of the
existing players.

T T Ram Mohan (ttr@iimahd.ernet.in) teaches

at the Indian Institute of Management,
Ahmedabad.

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s promised, the Reserve Bank of

India (RBI) has come out with
draft guidelines for on-tap bank
licences. Earlier, the RBI gave out bank
licences for universal banks in occasional
bursts. There was one round of licensing
following guidelines issued in 1993 when
the RBI issued nine bank licences. Subsequent to fresh guidelines issued in 2001,
another two bank licences were issued.
More recently, following guidelines
issued in 2013, the RBI issued licences for
differentiated banks, that is, payment
banks and small banks.
Need for More Banks?
Why do we need on-tap licences or
continuous authorisation of licences? The
RBI had spelt out the rationale in its discussion paper on banking structure in
August 2013. On-tap licensing would put
pressure on existing banks and help
improve competition and efficiency. It
would bring technology and new ideas
into banking on a continuous basis. A
gradual increase in the number of banks
would be better than sudden increases
as the latter would strain both banking
and regulatory resources.
These arguments are not as compelling as they sound. Yes, we need competition in banking and improvements in
efficiency but these should not happen at
the cost of stability in banking. Today,
banks are groaning under the weight of
the legacy of non-performing assets.
Putting pressure on them by letting in
new players cannot be the priority.
Again, we do not necessarily require
new players to bring in technology and
new ideas. In a reasonably competitive
banking structure, there will be pressure
on banks to innovate and improve technology, and we have seen this happen
across the board, with public sector banks
(PSBs) too upgrading their technological

capability significantly. Stop-go licensing need not mean a large number of

players at one go; the regulator is free to
determine how many additional licences
it needs to issue at a given point in time.
The contention that continuous authorisation has been in place for foreign banks
and, therefore, a similar regime is appropriate for domestic banks is also not persuasive. Foreign banks were long subject to
stringent restrictions on branch expansion. Today, they are subject to stringent
requirements of subsidiarisation, independent boards and the rest. As a result,
there have been no takers despite the
RBIs offer to give foreign banks almost
the same treatment as domestic banks.
Continuous authorisation for foreign
banks is not translating into continuous
entry in the present environment.
Will it be any different with domestic
banks? Merely because on-tap licensing is
available, does it mean that we will have a
rush of applicants? The question is particularly relevant given the experience with
payment bank licences. So far, three out of
the 11 entities given licences have said
they are not going ahead with their plans.
Who Can Enter Banking?
The answers become clear when we
look at the eligibility criteria. The draft
guidelines mention three types of eligible promoters:
(i) Non-bank financial companies (NBFCs)
controlled by residents and with a track
record of at least 10 years.
(ii) Professionals with 10 years of experience in banking and finance.
(iii) Private sector entities controlled by
residents and with a track record of at least
10 years. Such entities should have assets
in excess of `50 billion and the nonfinancial business of these entities should
not exceed 40% of their assets or income.
Not many NBFCs have shown an appetite for converting into banks. For wellestablished NBFCs with relatively large
balance sheets, the priority sector conditions that commercial banks are required
to meet have proved a significant deterrent. This is the reason why many of the
better-run NBFCs did not care to apply for
a bank licence in the last round.

JUNE 11, 2016

vol lI no 24

EPW

Economic & Political Weekly

HT PAREKH FINANCE COLUMN

The experience with professionals

has, at best, been a mixed one. In the
first phase of private bank licences,
which happened in 1993, the experience
was not a happy one. In the second
phase, which commenced in 2001, the
experience has been better. We must
recognise that the competitive situation
in banking is pretty demanding at the
moment. A financial institution, such as
IDFC, which was given a bank licence in
the last round, has indicated that it will
take about nine years to stabilise its
operations! The prospects for individuals venturing into banking on their own
are not very promising.
There is every possibility, however,
that individuals can venture in with the
backing of industrial houses. Corporate
houses can have an equity stake of up to
10% in a bank. The promoter will have a
minimum equity stake of 40% to start
with. This will have to be brought down
to 30% within a period of 10 years and
15% within 12 years.
The limit for foreign investment in a
bank, including by foreign institutional
investors (FIIs), is 74%. We often hear of
corporates bringing funds into the country through the FII route. It is conceivable, therefore, that 10 or 12 years after a
bank is promoted by a professional, control can effectively pass into the hands
of corporates.
Banking on Corporates
As mentioned earlier, corporate entities
are permitted to set up a bank provided
their non-financial assets or income do not
exceed 40% of the total assets or income.
In other words, the entity is primarily a
financial company. Some of the leading
industrial houses may not meet this criterion but there are entities that do.
It is clear that it is corporate houses or
those with the backing of corporate
houses that are best placed to enter the
banking sector today. The draft guidelines thus raise a basic question: where
does the RBI stand today in relation to
the entry of corporate houses into banking? In 2013, when the RBI announced
its guidelines for new private bank
licences, it made a significant departure
from past policy in throwing the field
open to industrial houses.
Economic & Political Weekly

EPW

JUNE 11, 2016

One argument made at the time was

that industrial houses had the deep
pockets necessary to provide meaningful competition to entrenched players. It
was also argued that the restrictions on
interconnected lending were stringent
enough and the RBI also had the capability to monitor these closely.
As it turned out, not a single industrial
house was granted a licence. Bimal Jalan,
who headed the screening committee
that reviewed applications, explained
the seeming contradiction by saying that
while the RBI was open to industrial
houses, the fit and proper criteria would
have to be met. This appeared to imply
that none of the industrial houses that
had applied for a licence had met the fit
and proper criteria.
I recall discussing this issue with
senior RBI officials. They told me that, at
the time it was decided to open up the
sector to industrial houses, the 2G and
other scams had not erupted. Had they
known that industrial houses had not
really changed their ways, they said, the
RBI would have been more circumspect.
It is worth asking what has changed
since. And if it has not, it is not sensible
to let corporate houses coming in through
a 10% equity stake or by letting in predominantly financial companies that
have interests in non-financial areas. It
would be best if the RBI sets its face
unambiguously against corporate houses
having any presence in banking. Indeed,
this was the stance taken by the Committee on Financial Sector Reforms
(2008) headed by Raghuram Rajan.
Priorities of Banking in India
The problem is not just the dangers of
interconnected lending and their implications for financial stability. It is that
large corporate houses, with their strong
links to the political class, may not be
entirely amenable to the sort of stringent
regulation and supervision one associates
with the RBI. There is every danger that,
in any conflict between the RBI and a
corporate entity, the former will lose
out. The RBIs enviable standing as a regulator will be undermined as a result.
Nor is there any compelling need to
allow corporate houses to enter in one
form or another. First, there is adequate

vol lI no 24

competition in Indian banking today.

The share of PSBs in assets has been falling over the years even as private banks
have gained ground. On some estimates,
the share is expected to fall from around
70% today to 60% in a decade from now.
It is fair to suggest that this pace of
growth of market share of private banks
is consistent with improving efficiency
in banking while maintaining stability.
Second, there is a contradiction in
saying that we need more competition in
banking even while arguing for consolidation of PSBs. This contradiction could
be resolved by saying that more competition means the share of PSBs must
shrink more rapidly than it is at present.
This proposition can be questioned given
the general state of governance in the
private sector, it is not clear that we gain
by accelerating the increase in private
banks market share.
But if this is indeed the RBIs position,
it must state it explicitly and throw up
the issue for political debate. Remember,
if there is one issue on which there is
consensus across the political spectrum,
it is on the need to retain the pre-eminence of PSBs in the banking sector.
Third, banking is in a highly stressed
state today and the stresses are to be
found amongst both PSBs and private
banks. The priority over the next two or
three years has to be the resolution of
the non-performing assets problem and
strengthening of the existing players.
Entry of newer players, especially those
with corporate backing, cannot be the
priority at the moment.
Hastening towards the multi-tier
structurewith three or four large international banks, a few national players,
regional players and local players
advocated by the Narasimham committee cannot be a priority either. In the
present condition of the PSBs, saddling
them with the formidable challenges
of managing mergers just does not
make sense.
In sum, on-tap licensing may sound
very appealing; it has just the right
reformist air about it. It would be more
prudent, however, to resolve the serious
issues in banking today before thinking
of shaking up the system in the name of
more reforms.
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