Don’t just bank on new banks : Mar 15, 2010 Financial Express

The Union Budget has given a signal that the government is not averse to having more private sector banks in the country. The reason ostensibly is to spread the reach of banking and usher in more competition. The introduction of new private banks did bring in technology and better quality of service; and the logic of competition forced public sector banks to follow suit. This has been the good part of the story. There is also the other side to this story which needs to be kept in mind. One may recollect that of the original 7 private banks, only three have survived, which are institution-driven. Three have sold out to other banks, while one was taken over by a public sector bank. Therefore, the history of new banks doing well and surviving has been a mixed one. One is not too sure if the promoters are after valuation or out to create value for the system. Banking today could be seen as a steady business which also gives high valuation in the market. There could be an incentive to finally sell out to the highest bidder in due course. Here, RBI would need to take a commitment from the promoter that there could be no exit route under normal circumstances for a fixed period of time. The other issue really is the physical infrastructure. RBI has been reiterating its stance on the need to obviate the creation of duplicity in infrastructure in the banking infrastructure such as ATMs. The concept of shared ATMs has gained currency in the country. The creation of new banks would necessarily have to address this issue. Similarly the question of having branches in areas which are already heavily ‘banked’ may not add value. If the aim is to spread to new areas, the same could be permitted for the existing ones. The more obvious issue that has to be addressed is the one relating to promoters’ background. There would be a conflict of interest in case the promoter has a business which depends on finance. Corporate houses so far have been kept out of the ambit, which is likely to change in the new scheme of things. While regulation should ensure that such conflict of interest does not arise as there could be rules on the dos and don’ts of banking, the broader issue really is of the risk in non-banking activity spilling over to the.banking sector. This would need to be separated clearly, especially in the light of the recent financial crisis, where spillover of risk from one business segment to the other had hastened the process of decline. The NBFC business, which is relatively more risky would have to address this question when converting to or floating a bank. At the ideological level the question to be raised is whether there is really need for more banks. Two issues emerge. The first is whether there is a lacuna in provision of banking facilities. The answer here is no, because the network is large and mere additions of new banks which would focus on urban centres on grounds of viability, will not address the issue for the un-banked people. Further, the reasons for a large section of people being out of the system are not the absence of adequate banks but one of access on account of their creditworthiness. Small borrowers can be addressed through micro-finance institutions and not more banks. The other issue is whether more banks will add to competition. Banking is largely regulated by RBI with all interest rates of products being monitored. Further, when banks had freedom in pricing of services, there were instances of profit-seeking by some banks, which forced the Ombudsman to reinforce control over these rates and also usher in transparency. Often it is felt that there is not much difference between banks, as the menu of products and services are almost identical. In such a scenario, the addition of say another 2 or 3 banks is unlikely to change the canvas. While a free society should allow more players to enter, the entry and regulatory costs are high. With restrictions on banking operations within the present circumference, getting in more players may not achieve the goal. Instead, our thoughts should get centralised on making the existing banks stronger, especially in terms of capital, which can be organic or inorganic through the M&A route. The other set of institutions such as RRBs, micro-finance institutions, cooperative banking and NBFCs should be made more vibrant, because these are the institutions that are actually operating in areas which require more banking or quasi-banking facilities. Even if we do allow new private banks, it should be more on the principle of liberalisation, rather than the mistaken belief that they would even remotely do what the present structures are striving for.