Tuesday, 9 July 2013

Will the upcoming Banks survive the Licensing Ordinances?

‘The Indian Banking system has emerged unscathed from the crisis. We need to ensure that banking system grows in size and sophistication to meet the needs of modern economy. Besides, there is need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable members that RBI is considering giving some additional banking licenses to private sector players. Non-Banking Financial Companies could also be considered, if they meet the RBI’s eligibility criteria’.                                                                                          
                                                   -Pranab Mukherjee

              This was the statement made in the budget speech 2010-11 by the then Finance Minister Shri Pranab Mukherjee, after which RBI put a discussion paper on its website and year after draft guidelines were released for ‘licensing of new banks’ on RBI’s website on August 29, 2011. The final guidelines have been released after almost one and half years by taking into consideration the feedback to the draft guidelines from different stakeholders. And now that the guidelines for “Licensing of new banks in the private sector” had been finalised on February 22, 2013, let us first see what are the restrictions that seem challenging to the entities applying for the license for new banks.
1.      To get a banking licence, companies must show a 10 year track record of “successful” operation, a business model that isn’t speculative or vulnerable to volatile assets prices, and they must pass a “fit and proper” test.
2.      As per the 2013 final guidelines, promoters/promoter groups will be permitted to set up banks only through a wholly owned Non-Operative Financial Holding Company (NOHFC), which will hold the bank, as well as all other financial services companies regulated by the RBI or other financial sector regulators.
3.      The promoters should contribute minimum of INR 200 crores (40% of INR 500 crores), which shall be locked in for a period of five years from the date of commencement of the business of the bank. Any shareholding by NOFHC beyond 40% shall be brought down to 40% within three years from the date of commencement of business of the bank. The shareholding by promoter shall be brought down to 20% of the paid-up capital of the bank within a period of 10 years and to 15% within 12 years from the date of commencement of business of the bank and retained at that level thereafter.
4.      Also, there is restriction on the shareholding patterns of FDI, FII’s and NRI’s. Their shareholding in new banks should not increase 49% for the first five years from the date of licensing of the banks. After 5 years, this foreign shareholding can be increased to 74% of the paid-up capital.
5.      The final guidelines mandated that the new bank will open at least 25% of its branches in unbanked rural centres (population up to 9,999 as per latest census). At present, existing banks are also required to allocate at least 25 percent of the total number of branches proposed to be opened during a year in unbanked rural (Tier 5 and Tier 6) centres.
6.      The banks have to maintain a capital adequacy ratio of 13% of its risk weighted assets for a minimum period of 3 years. Another being, banks have to list their shares within 3 years of the commencement of business.
7.      Also the promoters/promoter groups with an existing NBFC will have restructure in terms of business alignment and tax implications and along with that they have to comply with the norms on reserve requirements and priority sectors.
8.      There is restriction on NOFHC to setup any other financial services entity for next 3 years from the date of licensing.
As we have seen so many challenges before the promoters, let us see what the implications of the same are.
1.      First challenge will mainly affect the industries that are volatile in nature like brokerage, real estate companies. Though RBI opened the way for them but still it will be tough for these industries to abide by the business model and “fit and proper criteria.
2.      As per the second point, the promoters will have a tough time because they may have to restructure their existing financial businesses under NOFHC.
3.      Third challenge will be faced by the promoters as they will be held accountable for the bank (possessing 40% stake initially) and also they have to prove their ability to provide a good track record.
4.      Fourth restriction is mainly imposed because RBI wants to discourage any influence on the Indian banking industry by any foreign entity.
5.      Fifth point will put pressure on the new entities and the entities which have their operations only in urban areas. Branches in rural areas are essential to address the existing asymmetries in achieving financial inclusion, which RBI is trying very hard to accomplish.
6.      To maintain CAR of 13% will be tough as promoters may have to go slow on growth and they may have to provide evidence of their sustainability and also listing within 3 year time frame is tough.
7.      Here NBFC’s have to convert their branches to bank branches which will require much of restructuring. Also, RBI is attempting to avoid control by the promoters as well as ensure the commitment of the promoters. The norms for issuance of new banking licenses include Promoters eligibility, Fit and Proper criteria, Corporate Structure of the NOFHC, Corporate Governance, prudential norms etc. 
8.      Not setting up any other financial entity is to protect the public interests.
          According to RBI estimates, almost 40-45% of the population in India, does not have any access to Banking services and is presently outside the purview prevailing banking system. Hence there was a need felt, to bring this population to the main stream by various measures under the heading of Financial Inclusion to ensure inclusive economic growth, without regional imbalances.
         As of now, RBI had received 26 public, private applications for new licenses. So, on this RBI Governor said that not all the applicants fulfilling the eligibility criteria will be granted the license. Also, the applicants with more NPA will be at risk. This objective of financial inclusion will place a heavy demand on profitability and capital. It will also result in the new banks taking a long time to get established. So profitability of the new banks will be limited till they secure a strong foothold.
        It is quite clear from the number of applicants which is very less as per the market's expectation, reflecting that there are stricter regulations and high barriers to entry that limit the competitive advantage of getting a bank licence, especially for established non-bank financial institutions (NBFI).
        Despite the restrictions on new licenses, the investors see room for expansion. There are large conglomerate-backed entities like Aditya Birla Nuvo, L&T Finance and Reliance Capital in the fray. The last named has roped in two Japanese partners in Mistui Trust Bank and Nippon Life Insurance. Financial services players like India Infoline, Edelweiss Capital and Religare have also thrown their hats into the ring. There is also India Post, with its huge countrywide network of post offices and deposit mobilisation machinery.
        1993-2001 experience in the banking sector was good and encouraging. Private banks like ICICI, HDFC and YES bank showed tremendous growth and are considered in top private players in the banking industry. Consequently, share of public banks came down from 90% in 90’s to approximately 75% currently. Under the new banking norms the requirements are tough. 
         Concluding, in the short term, new private banks will have to work hard so as to establish them and protect the interest of the shareholders. As currently the banking coverage is 6.3 per lakh or we can say 7 lakh branches approximately which show our country is under banked. So there is a lot of scope for new banks to spread the wings all over the country to derive the full benefit, supported by strong technical and adequate capital as well as risk mitigation. There is a lot of attention on financial inclusion as well as priority sector lending. It is expected that overall the new banks will do well, but the initial period may be little more challenging than what the earlier private banks underwent.


“This article is written by Ms. Bhanupriya Gupta. She is a PGDM student of 2013-15 batch of IIM Raipur. She holds a Post Graduate Diploma in Securities Markets from National Institute of Securities Markets. She can be reached at pgp13009.bhanupriya@iimraipur.ac.in.”

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