New banking license for private player

According to the discussion paper to be released this week, aspiring banks

seeking a licence may be asked to form compulsary alliances with regional rural
banks (RRBs) to help them begin operations on a wider footprint, as also to
hasten financial inclusion in the nation.

The Reserve Bank of India (RBI) is expected to set stringent conditions that new
banks must open a certain minimum number of branches in unbanked areas,
according to an RBI official.The central bank is scheduled to finalise the draft
guidelines for new bank licences this month and some bankers expect these to
be announced with the quarterly monetary policy review on tuesday the 27th of
July 2010.

An internal committee of the Reserve Bank of India has been working on the new
banking license guidelines for some months now. The minimum required capital
is expected to be set at Rs 500 crore initially, with a provision that it be raised to
Rs 1,000 crore within 3 years of issue of the license.There is a growing capital
requirement if the economy has to grow faster than the 8.5 per cent it is
expected to grow by March 2011. Foreigners are expected to be permitted to
invest up to a maximum of 20 per cent, the sources revealed.

NBFCs and the private sector can now enter the banking business if they meet RBI’s criteria. This is
a major move for the financial sector

Private players and non-banking finance companies (NBFCs) have reason to cheer the Budget speech as
the finance minister announced that the RBI is open to giving them banking licences if they meet the apex
bank’s criteria.

“The RBI is considering new bank licences to promoters in the private sector and also NBFCs, if they meet
the eligibility criteria of the RBI,” Pranab Mukherjee said while presenting the annual Budget for 2010-11 in
the Lok Sabha.

NBFCs like Indiabulls, Reliance Capital, Religare, IL&FS, IDFC and Aditya Birla Financial Services are likely
to apply for bank licences after the RBI norms are in place.

“The Aditya Birla Financial Services Group is already a large non-bank player occupying a significant
position across all its verticals. We wholeheartedly welcome this initiative and will definitely apply for a
licence. The Aditya Birla Group is confident that we will meet any eligibility criteria that might be set," said
Ajay Srinivasan, chief executive (financial services), Aditya Birla Group.

“The finance minister has shared the government's desire to open up the banking sector to NBFCs and the
private sector. This is a significant step towards further strengthening and broadening the banking sector
and bringing it closer to the aam aadmi,” adds Mr Srinivasan

No new banks have been set up in the past eight years. In fact, no new Indian bank has been set up since
the first flush of liberalisation in 1993 when half-a-dozen banking licences were given. This announcement
clearly demonstrates the government’s plans for liberalisation of the financial sector.
India has 96 scheduled commercial banks (SCBs)—27 public sector banks 31 private banks and 38 foreign
banks—having a combined network of over 53,000 branches. According to a report by ICRA, public sector
banks hold over 75% of the total assets of the banking industry, with the private and foreign banks holding
18.2% and 6.5%, respectively.

Unlike banks, all NBFCs cannot accept demand deposits. Only NBFCs which hold a valid certificate of
registration with authorisation to accept public deposits can do so. NBFCs that were earlier allowed to be
converted into banks were Kotak Mahindra Finance and 20th Century Finance. While Kotak has diversified
into various financial services, 20th Century became Centurion Bank; it was taken over by a bunch of private
equity investors and eventually merged with HDFC Bank. Two of the other new licensees in the early 1990s
—HDFC Bank and UTI Bank (renamed Axis Bank)—have become very successful private banks.
the banking system requires substantial amount of capital and RBI’s move will
give an opportunity to NBFCs to participate.
The Reserve Bank of India has been hawkish on banks for not adhering to its directives of opening of no-
frills, zero-balance accounts in rural regions.
It says majority of the population specially the semi-urban and rural mass are not getting access to various
financial services availed by people residing in urban areas.

Hence, the apex bank has come out with a discussion paper on entry of new private banks to broaden the
reach of banking in the country.

Proposal for entry of new banks

Non-banking financial companies (NBFCs) can be granted banking license as it is already regulated by RBI
and hence the fit and proper concerns can be addressed easily.

On the flip side, their ability to run a bank is questionable as these institutions will now have to face stricter
guidelines and norms of a bank if granted a banking license. NBFCs are allowed to work on a lighter
regulatory framework as compared to banks.

The RBI is sceptical about granting banking license to industrial houses as the negatives by far outweigh
the positives. Though the industrial houses can be a source of capital and provide the adequate expertise in
running a bank, these houses might create conflict of interest through dealing with its own group companies
neglecting the other clients.

This may serious dent the purpose of allowing new banks by RBI. The Central bank also adds that any
industrial house involved in real estate should not be allowed to run a bank.

RBI has also opened up a debate on what should be the capital requirements to ensure only those entities
serious about participating in financial inclusion plan gets the license.

Hence, it has proposed that the capital requirement should be in the range of 300 crore to Rs 1,000 crore
( 3 billion to 10 billion). However, setting a low capital requirement will allow companies with limited ability
to invest in technology to enter banking sector.

On the shareholding pattern, RBI proposes that the promoters share should decrease on increasing equity
base. That is to say, if the equity base is below 1,000 crore ( 10 billion), promoters can hold up to 40 per
cent of capital; if the equity base is between 1,000 crore (Rs 10 billion) and 2,000 crore ( 20 billion),
promoters can hold up to 20 per cent of capital; if the equity base is above 2,000 crore ( 20 billion),
promoters can hold up to 10% of capital.

This model will ensure that the banks get support of promoters in the initial years and after it grows to a size,
it is run on a professional model.

The apex bank might allow foreign capital to promote domestic banks. However, it will not be in sync with
the current FDI policy which allows 74 per cent foreign equity in private sector banks.

Impact on consumer

As more players enter the banking space, intense competition among the banks might benefit the
consumers. Banks will focus on reducing their operational cost which in turn will result in charging lower
interest rates to consumer in the long run.

If NBCFs are given the preference to run a bank, then rural and semi-urban consumers will be most
benefitted.

As NBFCs cannot take demand deposits, their cost of funds are high as compared to banks. When banking
license will be awarded to NBFCs, their cost of deposit will be substantially reduced the benefit of which may
trickle down to the customers in semi-urban and rural areas.

More strategic tie ups can be seen with micro-finance institutions which may help to broaden the reach of
banking in several villages.

SMEs and small borrowers operating in Semi-urban or rural areas might get access to cheaper loans as
more and more banks expand their network in the face of intense competition.

To conclude, there seems to be a positive impact on consumers especially in semi-urban and rural areas if a
few private players are granted banking license.

Consumers in urban areas will also be benefitted when the more and more private banks will try to woo the
customers with attractive services.

Post budget 2010, the RBI may have to re attend to the banking license norms or adopt even
strict measures.

After the Finance Minister's announcement during the union budget 2010-11 that private
sector players may obtain fresh bank licenses and NBFC's may get banking license, over a
dozen NBFCs are harboring ambitions to convert themselves to banks. Under the current set
of RBI guidelines, in order to qualify as a bank, an institution should have a minimum net
worth of Rs 300 crore, and no single entity or group of related entities can hold more than
10% in a bank.
There seems to be a chance that the RBI, in a new directive may increase the minimum net
worth requirement to at least Rs 500 crore.

The large number of non banking asset finance companies eyeing a bank license includes
Aditya Birla Group, Tata Capital, Anil Ambani-led Reliance Capital, Malvinder Singh-led
Religare group, Muthoot Group, Bajaj Group and Shriram Finance.
Other players like Indiabulls, Exim Bank, SIDBI and IFCI are also expected to look into the
prospects of getting a bank license. By becoming a bank, we will be able to raise low-cost
deposits and provide working capital support to a large number of small enterprises.

The key criterias which RBI may look at before arriving at any conclusion are diversified
ownership, distinction of ownership from fit and proper management, ability to infuse.

3 rd november

Banking and monetary regulator, Reserve Bank of India has declared that the draft guidelines
for giving new bank licenses to eligible contenders will be ready by January.

A discussion paper had been introduced by RBI in August seeking suggestions and
recommendations on the issue.

There are a large number of big corporate entities as well as non banking finance companies
(NBFCs) in the race to get a license to bank in India. Amongst them are Reliance Capital, the
Aditya Birla Group and the Tatas including Shriram Finance, LIC Housing and Mahindra
Finance.

"Based on the comments and suggestions received from various parties and discussions held
with major stakeholders in October 2010, it is proposed to put the draft guidelines in the
public domain by end of January 2011," the central bank said in its second quarter policy
review.

In 1993, when India first opened up the banking sector to private firms, the objective was to
infuse competition. To a large extent that has been fulfilled, as the so-called new generation
private banks such as ICICI Bank Ltd, HDFC Bank Ltd and Axis Bank have forced India’s staid
public sector banks to become more nimble-footed. But these banks have not been able to
spread banking across the country as their focus has all along been on urban India.

Under the regulation, all banks need to set up at least one branch in rural and semi-urban
India for every three branches in urban India, but these banks are not excited about the
business prospects in rural India. Similarly, under the licensing norms, they needed to have
their registered office outside the metros. Indeed, they have their registered offices in Pune,
Vadodara and Ahmedabad and such places, but this only ensures that they hold their annual
general meetings there while the business focus remains on the over-banked metros. At least
one private bank has even sold its registered office in a non-metro to a public sector bank!

Some RBI officials say the metros should be declared no-entry zones for the new set of banks
and they should be asked to focus only on rural and semi-urban India. But that may not work
unless they are given enough incentives and regulatory forbearance such as lesser reserve
requirements, etc. Former finance minister P. Chidambaram in the late 1990s mooted the
concept of local area banks but they never took off in the absence of incentives.

They could be allowed in urban India as well. When competition intensifies, bank margins will
be under pressure and both the new entrants as well as existing banks will be forced to reach
out to rural India looking for new business.

RBI opened doors for private firms in the banking space in 1993; in 2003, it had allowed two
more to set up shop.

After seven and half year RBI issued private banking licence to Kodak Mahindra Finance Ltd.
The last private bank was set up in September 1995 when IDBI Bank, promoted by a financial
institution, got a banking licence. KMFL is the first instance of an existing non-banking finance
company becoming a bank.

The Reserve Bank of India is considering a 50 per cent cap on foreign investment in
new banks with a 10-year lock-in and keeping out corporate groups involved in real
estate business.
Banks are now allowed to have up to 74 per cent foreign shareholding, of which 49
per cent can be held by foreign institutional investors and 24 per cent by non-
resident Indians. The government treats banks with more than 50 per cent foreign
shareholding as non-resident-owned banks.
In its discussion paper on new private sector banks released today, the central bank
has also suggested a higher capital requirement than the existing Rs 300 crore for
new bank licensees.
RBI said the minimum capital of a new bank must be higher than Rs 300 crore, while
seeking a debate on the need for minimum capital of Rs 500 crore that could be
raised to Rs 1,000 crore. In 2001, RBI had set a minimum capital requirement for
banks at Rs 200 crore, which was to be increased to Rs 300 crore in three years.
RBI also opened discussions on the option of permitting promoters to hold on to as
much as their initial 40 per cent stake. In its earlier norms, promoters, after a five-
year lock in, had to dilute stake to below 10 per cent. RBI described its approach in
2001 as cautious for keeping out corporate houses and limiting ownership stake of
companies owned by them to 10 per cent.
RBI also listed out rules in 10 global jurisdictions and nowhere found clear-cut laws
banning industrial houses from owning or running banks.
Though the discussion paper did not say whether the 50 per cent cap on foreign
investment in private sector banks should apply to the new banks only, or will hold
true for the existing ones as well, some industry experts said the new cap could be
for all.

A larger number of banks would foster greater competition, and thereby reduce costs and
improve the quality of service,” the central bank said.

Surviving The Shakeout

Financial services — especially banking — is the most attractive business today. In a throwback to the
middle of the past century, the banker is a pillar of the community besides being among its most important
people. Little wonder then, that aspirants for a banking licence are likely to be drawn from across the
country’s corporate spectrum.

“New entrants will change the game as in 1994,” says Monish Shah, director of Deloitte (India), on whether
new players need to be brought in given the past experiences. “Issues such as how many will last and
shareholding are short- to medium-term in nature, and will sort out as time goes by.” Shah’s point: fresh
blood is needed. And if there is going to be blood-letting, so be it.

“The issue is not just about new licences,” says Rana Kapoor, managing director and CEO of Yes Bank.
“The RBI must take a look at the entire banking topography.” Kapoor refers to the mixed experience of new
banking licences issued in the first flush of financial reforms, the stalled growth of the eight old private
banks, and the scores of regional rural banks (RRBs) that are gasping for capital and searching for a bold
new path. This last group has to be getting on the same track as existing private, state-run and foreign
banks, which are in higher orbit.

Of the 10 banks that got licences in 1993, four were promoted by individuals. Only one of them has, some
say barely, survived: IndusInd. Three are history. Ramesh Gelli’s Global Trust Bank (GTB) played wildly,
taking on huge capital market exposure, and eventually fell apart.

PAST IMPERFECT OF THE FOUR BANKS PROMOTED BY INDIVIDUALS, ONLY ONE — INDUSIND —
HAS SURVIVED; THAT TOO BARELY

Oriental Bank of Commerce had to pick up the pieces. Dev Ahuja of Centurion Bank and Darshanjit Singh of
Bank of Punjab threw in the towel. They merged first and then got bought out by HDFC Bank.

Of the rest, Bennett, Coleman & Co.’s TimesBank merged with HDFC Bank in its fifth year. Development
Credit Bank, which had upgraded itself from a co-operative bank, is still finding its feet. ICICI Bank and IDBI
Bank re-merged with their parents. UTI Bank has been rebranded Axis Bank. HDFC Bank, along with Axis
Bank, is the only standalone start-up bank left from round one.

The RBI had also made a bad call or two; first in giving Chain Roop Bhansali’s CRB Capital a licence, which
was a non-starter as Bhansali became the target of a fraud investigation. And in a knee-jerk reaction, it
revoked the in-principle licence granted to Cox & Kings, a subsidiary of Indian Hotels run by the Tatas.
The 2001 Ketan Parekh-Madhavpura Credit Co-operative Bank fiasco also shaped the regulatory
disposition. In 2003, the RBI played it safe by giving the nod to just two: Kapoor and Uday Kotak of Kotak
Mahindra Capital. Bimal Jalan too was in the last lap of his long vigil as the RBI governor (he became a
Rajya Sabha member in the second half of that year). It also made sense to cut out fancy footwork on
another account: the ruling coalition at the Centre, led by the Bharatiya Janata Party, was optimistic about
putting on a better show at the national hustings in the summer of 2004.

A case was made for permitting the entry of business houses into banking. The logic was that the presence
of big houses will intensify competition and improve the quality of service. And in order to stop the practice of
“managing the show from the background”, a view gained ground that promoters — and not professional
managers — should don the mantle of executive chairmen of such new banks.

TIMESBANK
Promoted by Bennett, Coleman & Co, TimesBank was the first to call it
quits. It set up operations in 1995, under N.G. Pillai, who was roped in
from State Bank of India. Pillai quit in 1998, and was replaced by Nani
Jhaveri from ANZ Grindlays in Melbourne. The Jains saw the writing on
the wall for the bank; sold it to HDFC Bank in 2000

GLOBAL TRUST BANK

It was a venture set up by Ramesh Gelli, Jayant Madhab and Sridhar
Subasri. GTB was the most aggressive private bank when it started out.
This, and its bourse flirtation, proved costly. Corporate governance, too,
was at a discount. In late 2004, the RBI put it under moratorium. It was
force-merged with the Oriental Bank of Commerce later
Back To The Future?
What are the chances for corporate houses at this point in time? Well, there appears little by way of the
position in 2001 when large industrial houses were not permitted to promote new banks. Individual
companies, directly or indirectly connected with large industrial houses were, however, permitted to own 10
per cent in a bank, but without any controlling interest.

The RBI discussion paper gives the pros and cons. The latter is justified on the grounds that “the Japanese
experience with Keiretsu, the Korean experience with Chaebols and the Indian experience before
nationalisation are strong reminders of the pitfalls of commercial interests promoting and controlling banks”.
If that is not a dead giveaway, here’s some more that shows the central bank’s inclination.

“The experience of the Reserve Bank over these 17 years has been that banks promoted by individuals,
though banking professionals, either failed or merged with other banks or had muted growth,” notes the RBI.
“Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy
people, strong and competent managerial support could withstand the rigorous demands of promoting and
managing a bank.”
Learning From History

The success of HDFC Bank and a few others are instructive. Apart from the professionalism and the
technology advantage, the attention being given to risk management is an important contributor to their
success. Given the recent global crisis, risk — and the threats to system stability from bad management of
risk — is going to count significantly with RBI.

The themes in the discussion paper have been partially dismissed as a recounting of history that has no
place in the current situation. “We live in a completely new economic era,” says the head of a large global
investment bank. “Applying old thinking to a new global economic order seems a little retrogressive.”

At the end of this month, another discussion paper — on the entry of foreign banks — will be put out after
incorporating the comments received. Later, there may be another paper on a prospective Bank Holding
Companies Bill. The central bank is looking at the issues — capital requirements, the entry of conglomerates
and foreign banks, and whether NBFCs should be considered as candidates — in as much totality as it can.
Finally, it is the RBI’s view that matters. And you can bank on that.
Is Old Gold?
There is a case for making old banks on a par with new private banks. Some like Lakshmi Vilas Bank (LVB)
have started to step out. It is said to be in talks with Citigroup to buy its beleaguered non-banking finance
arm, CitiFinancial Consumer Finance. Yet, it is a small bank. Says P.R. Somasundaram, managing director
and CEO of LVB: “The new draft norms are premised on the fact that size matters. But can you deny that we
service a lot many who otherwise do not have access to bank capital?”

Somasundaram’s peer at Dhanlaxmi Bank, Amitabh Chaturvedi, has a slightly different view. “If you are
going to say that we have no place, that new private banks will take us over, well, it is not the case. The
culture of old private banks is different. Size does matter, but there will be consolidation among the old
south-based banks,” he says.

But change seems under way, in four of these banks — LVB, Dhanlaxmi, Federal Bank and Ratnakar Bank,
whose chief executives are relatively young, all under 50. For a long time, the heads of these banks were
retired senior officials of state-run banks. The job was almost a retirement perk for them, and they did little of
note. The RBI, on its part, has made it clear that there is no space for banks with assets less than Rs 40,000
crore and 500 branches going forward. They should merge or grow aggressively.

Private banks also did not do great favours to their image. Forget the laggards for a moment. There was a
botched merger: GTB with UTI Bank. There were rumours of insider trading in GTB. The refrain was how
could have UTI Bank got it wrong by selecting GTB as a potential merger partner?

And then, there is financial inclusion. So far, rural lending — or priority sector lending — has been a
substitute. “I have no doubt that the RBI and the finance ministry are clear that there has to be a new
thinking on this,” says one banker. The structure of RRBs and urban-cooperative banks has failed to foster
financial inclusion, thus the idea that corporates be allowed an entry into these banks.

Many of these banks suffer from a low capital base, have poor corporate governance, and lack vision. In the
case of RRBs, the revenue model is topsy-turvy. State governments and state-run banks hold stakes in
them; they also compete with their sponsor banks and employees also get paid on a par. This is not a
sustainable model at all.