Banking and Financial Institutions Assignment On Licensing of new banks in the private sector

Craig Patrick Williams BBA 6th Semester Amity Global Business School, Kolkata

Key features of the guidelines are:

(i) Eligible Promoters: Entities / groups in the private sector, entities in public sector and Non-Banking Financial Companies (NBFCs) shall be eligible to set up a bank through a wholly-owned Non-Operative Financial Holding Company (NOFHC). (ii) Fit and Proper criteria: Entities / groups should have a past record of sound credentials and integrity, be financially sound with a successful track record of 10 years. For this purpose, RBI may seek feedback from other regulators and enforcement and investigative agencies. (iii) Corporate structure of the NOFHC: The NOFHC shall be wholly owned by the Promoter / Promoter Group. The NOFHC shall hold the bank as well as all the other financial services entities of the group. (iv) Minimum voting equity capital requirements for banks and shareholding by NOFHC: The initial minimum paid-up voting equity capital for a bank shall be `5 billion. The NOFHC shall initially hold a minimum of 40 per cent of the paid-up voting equity capital of the bank which shall be locked in for a period of five years and which shall be brought down to 15 per cent within 12 years. The bank shall get its shares listed on the stock exchanges within three years of the commencement of business by the bank. (v) Regulatory framework: The bank will be governed by the provisions of the relevant Acts, relevant Statutes and the Directives, Prudential regulations and other Guidelines/Instructions issued by RBI and other regulators. The NOFHC shall be registered as a non-banking finance company (NBFC) with the RBI and will be governed by a separate set of directions issued by RBI. (vi) Foreign shareholding in the bank: The aggregate non-resident shareholding in the new bank shall not exceed 49% for the first 5 years after which it will be as per the extant policy. (vii) Corporate governance of NOFHC: At least 50% of the Directors of the NOFHC should be independent directors. The corporate structure should not impede effective supervision of the bank and the NOFHC on a consolidated basis by RBI.

(viii) Prudential norms for the NOFHC: The prudential norms will be applied to NOFHC both on stand-alone as well as on a consolidated basis and the norms would be on similar lines as that of the bank. (ix) Exposure norms: The NOFHC and the bank shall not have any exposure to the Promoter Group. The bank shall not invest in the equity / debt capital instruments of any financial entities held by the NOFHC. (x) Business Plan for the bank: The business plan should be realistic and viable and should address how the bank proposes to achieve financial inclusion. (xi) Other conditions for the bank: The Board of the bank should have a majority of independent Directors. The bank shall open at least 25 per cent of its branches in unbanked rural centers (population up to 9,999 as per the latest census) The bank shall comply with the priority sector lending targets and sub-targets as applicable to the existing domestic banks. Banks promoted by groups having 40 per cent or more assets/income from nonfinancial business will require RBIs prior approval for raising paid-up voting equity capital beyond `10 billion for every block of `5 billion. Any non-compliance of terms and conditions will attract penal measures including cancellation of license of the bank.

(xii) Additional conditions for NBFCs promoting / converting into a bank: Existing NBFCs, if considered eligible, may be permitted to promote a new bank or convert themselves into banks.

Are the guidelines too stringent? Subbarao says welcome, but dont come in
The RBI has imposed stiff conditions for eligibility to enter the business. Among other things, new banks have to put up Rs 500 crore as capital on Day One. Then, 25 percent of their branches have to be in unbanked rural areas. The RBIs definition of unbanked areas is villages with a population below 10,000. Assuming this means 2,000 households, it means putting up a branch for fewer than 2,000 live accounts. A quarter of the branches will lose money from Day One. But just in case some intrepid promoters are undeterred by these hurdles, the RBI has set up two pole vaults in the end, which will check the enthusiasm of all but a handful of businessmen. One is the RBIs fit and proper criteria, which demands that promoters must have sound credentials and integrity (sounds good, but isnt that a given?); then they should have had a successful track record of 10 years (what is successful for the RBI?); and they must have a good rating from the other regu lators (if you have crossed SEBIs or IRDAs path unfavourably, watch out). But the biggest wet blanket is the condition that the promoter/promoter groups business model and business culture should not be misaligned with the banking model and 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.The RBI has always been against letting the likes of realtors or brokers or trading companies into the business. Since their business is all about speculation and asset price volatility, this rider will effectively keep them out. The final hurdle (or, shall we say, the biggest nail on the welcome mat?) is the RBIs clear warning that even if a promoter meets all its criteria, he may still not be allowed near the starting post for the banking race. This is what the RBIs guidelines ultimately warn: Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for RBI to issue licences to all the applicants meeting the eligibility criteria prescribed above. The counter-point one needs to make is simple: how many of our current public sector banks, not to speak of the new private sector banks, will even qualify on these criteria?

How many public sector banks would clear the hurdle of providing best international standards of customer service? How many private sector banks would qualify on the criteria of being inclusive? How many Indian promoters with the ability to plonk Rs 500 crore on the RBIs table would have impeccable credentials given that most of them are the products of crony capitalism and regulatory capture? Even the Tatas have the Radia tapes episode to live down, the Birlas got their telecom licences cancelled, and the Ambanis are in trouble with Sebi over alleged insider trading. How many existing banks from SBI to HDFC Bank got the rap from Sebi and the RBI for the IPO scam of a few years back? This is not to say that the RBI has no reason to be cautious about new entrants. From Global Trust Bank to Bank of Punjab to Centurion Bank to Timesbank, some of the shiny new entrants of the last wave of liberalisation did not manage to survive. Even UTI Bank (now Axis) and IDBI Bank managed to screw up before being rescued by PJ Nayak and Gunit Chadha. Success in private banking is not a given, no matter how well capitalised you are.

Proposed changes
The assumption that new private banks will help create financial inclusion by heading off to rural areas is debatable. Most rural branches are unprofitable, and if already profitable banks are not rushing in, then new banks are hardly going to be very keen to do so. They will probably go through the motions of going rural and focus on urban areas for business. It makes more sense to incentivise profitable existing banks to do so. It is easier for a profitable bank to support unprofitable new branches than for a new bank to start on an unprofitable note. The real issue about rural banking is that you need a low-cost business model to supplement the existing high-cost one. By prescribing a high entry cost (Rs 500 crore capital), and adding all the new prudential norms under Basel III, new banks will have higher costs than existing ones. What we need is to get banks to form relationships with existing micro financing institutions, non-bank finance companies, and private money lenders, who already have low-cost, out-reach capabilities. This will lead to better and cheaper ways of financial inclusion.