Why do we want more banks? 31st August 2011: Financial Express

RBI’s revised draft guidelines for new banks are a step towards the latter’s final fructification though there is a rider that the Banking Regulation Act has to be amended for the same. We will have to wait beyond October. Having new banks in the arena will be refreshing just as it was when the Narasimham Committee Report’s recommendations were adopted in the nineties. The success of new banks was mixed with the institution-backed ones along with a group-backed bank emerging ahead while several others got absorbed through acquisitions due to non-viability.

RBI has focused a lot on regulation to ensure that the ownership of these banks is in the right hands and that there is little exposure to the sensitive sectors such as real estate and capital markets. By insisting on R500 crore of capital, it does keep out the smaller players, but then that is understandable because we need banks with deep pockets which can meet other aspirations of domestic banking. Besides, from the point of view of monitoring banks, a smaller set of large banks is more convenient. Also, there are strict guidelines on the exposure norms which will ensure that there is no cronyism. How will the landscape of banking change assuming that we have some big players coming in?

On the positive side, having new banks will help to spread banking to the masses. We can see large corporate houses and NBFCs qualifying for the same, which will really help to expand the overall banking structure with the requisite technology. There was a sea change in the way in which banking was conducted in the nineties and the new set will increase competition and improve efficiency. By RBI insisting on 25% of the branches being in rural unbanked areas, these banks will support the drive towards financial inclusion.

NBFCs, in particular, should find this route useful as they already have strength in specific niche segments and by adhering to the compliance standards laid down by RBI they can actually reach out for the deposit base, which today is a high-cost one. They have their own distribution networks, which can be harnessed to take a firmer hold on this turf. It must be pointed out that banks have the advantage of accessing current and savings deposits, which are stable in terms of rollovers.

There are, however, some challenges for the new banks. They have to compete with well-established banks and bringing in incremental innovation is a task. Further, they could be pressurised by the norms for inclusive banking. We already have around 87,000 bank branches in the country.

Rural branches clock around R14 crore of deposits per branch while urban/metropolitan ones do R116 crore. Similarly, rural branches bring in an average credit ticket of R8.5 crore per branch while urban/metropolitan branches get in R96 crore. Clearly, there will be pressure on profit margins for these new players, especially so as they are beginning their business on this slippery note. Also, the priority sector adherence will be a tough one for new entrants unless allowed in a phased manner. It may be advisable to treat the priority sector commitments on line with those for foreign banks and include export credit as an option.

An issue to be debated is why we want more banks in the country. If it is to bring in more capital and foster competition, then we are on the right track. Large business houses with deep pockets are just the panacea that we are looking for given that if we are talking of credit growing at 20% per annum in the next 5 years, we are looking at incremental funds of almost R40 lakh crore which has to be supported by 10% CAGR.

The existing banks can certainly provide support given that they are well-capitalised, but with prudential regulation becoming stiffer, new banks are the answer.

However, bringing in the inclusive banking compulsion can be inhibiting. If we want to target the un-bankable class, then the approach should be different. We already have a large banking network in the rural areas which can bring about financial inclusion; it is not necessary to create fresh infrastructure. Instead, this would have been an appropriate time to actually bring in a new category of banks which would be dedicated to this niche group with different minimum capital requirements. This could have provided an opportunity for either existing players in the NBFC or the cooperative banking system to transform into a niche bank for this purpose. A thought that can be pursued is to see if these new entrants can acquire existing banks so that financial strength is delivered without recreating the infrastructure.

It must be reiterated that the Indian banking system is regulated quite closely through the SLR (25%) and priority sector compulsions (40%), with restrictions on sectoral lending. While these are prudential measures, at some point they can conflict with commercial considerations. So, a dualistic approach that separates inclusive banking from general banking may be a suggestion to consider.