Do we need more banks? The challenges are immense

Do we need more commercial banks in the system? This may sound heretical at a time when RBI has announced that it will provide licences on tap, subject to appropriate qualifications and prerequisites that have to be adhered to. Evidently, there would be a lot of scrutiny before permission is given.

This was the routine last time too, when only two entities were awarded a licence, which interestingly were closely related to the banking sector. The broader question is, whether we really require more banks at a time when we are trying to move more towards the disintermediation route and are working towards consolidating existing banks with size being one of the criteria?

The argument for having more banks is always compelling. More players means more competition, which leads to better products and services—this, in turn, benefits both deposit holders and borrowers. Importantly, it prevents the cartelisation of the business, which was the case before 1992. One area where this impact can be seen is in the differential interest rates offered by various banks even on savings deposits, thus actually providing options for the household. This was not heard of earlier. Further, with similar products being offered like credit cards and ATM facilities, the cost should logically come down as banks compete to maintain their market share.

In that case, what can be the counter-argument against having more banks? First, we have already given licences to several payments and small banks. There has been some hesitation shown by certain players in terms of apprehension after being awarded licences. Theoretically, these two categories of banks address the objective of inclusive banking in both the deposits and lending spaces.

Payments banks would be busy collecting deposits, while small banks will be lending to the underprivileged category classified under the priority sector. If this were to work out, then there would be a crowd in this space, which is relevant as these new banks have to adhere to the priority sector norms.

New banks would more likely be urban-based, to begin with. The conversion of existing offices in the rural areas to ‘rural branches’, especially if they are currently NBFCs or MFIs, will permit seamless transition. But will they be able to add a ‘delta’ in this space where there are several other players who are already there and who are competing in their own way with the aggressive Jan-Dhan of existing commercial banks?

This is a matter of conjecture. Therefore, unless there is a metamorphosis of an existing financial entity, which could be in small lending or truck finance or personal loan segments, starting afresh will be a challenge.

Second, in an era where we are talking of bank consolidation, especially in the area of PSBs, having more commercial banks could appear to be odd. The reason for consolidation is that smaller banks will not be able to meet the challenges of future growth of the economy. Therefore, having new banks start afresh will always be steps behind the existing players.

It has also been seen that so far the major success stories have been institution-backed private banks. The old private banks have managed to hold on and continue to operate in their limited territories, being community-based. There are, however, a few examples of non-institution backed banks which have done very well, but would be exceptions.

Given the scale that is required, we could be duplicating efforts if all the new banks open branches in the metro cities in areas where other banks exist. This will necessarily follow in case they are retail-based as this is where the money lies.

Third, RBI has been reiterating that it would like to divert customers to the corporate bond market because banks cannot bear the onus of financing infrastructure, given the asset liability management (ALM) issues as well as the NPA problem, which is rampant today. This being the case, having more banks begs the question: for who are we creating these new structures? Based on the central bank’s thinking that has been interpreted, banks are to remain more in the area of providing short-term finance with the bond market taking on the responsibility of long-term funding.

Fourth, if we look at the banking structure, almost always banks have kept excess statutory liquidity ratio (SLR) of up to 5% on a continuous basis, which gives a clue that either they are not enough worthwhile projects or there are companies seeking finance that do not impress with the credit rating, leading to hesitance on the part of banks to lend. Also, it has been observed that companies are progressively accessing the commercial paper (CP) market, where the cost is lower than that what is charged by banks.

Hence, having more banks may not really lead to more borrowing as long as this differential exists.
We certainly do have a curious situation in the financial sector. The so-called shadow banks, which includes NBFCs, MFIs, finance corporations, etc, would like to become commercial banks because they get access to cheap funds in the form of demand and savings deposits. This structure is well-defined and structured, which makes operations easier.

From the point of view of RBI, giving them legitimacy by allowing them to convert to banks makes sense, as these institutions come under the ambit of prudential regulation.

But, in the current context, where there are different waves of thinking on the banking system, having more banks just for the sake of having them may not look convincing from either the business angle or from the point of view of society. It would make a lot of sense for the entity in case it is an MFI or an NBFC, as it helps them to merge with the banking system.

Putting these points together, it can be argued that we may not really need more commercial banks today. There are incentives for existing institutions to convert to banks, which makes sense, but for a new entity coming in afresh, the challenges are immense. There are issues with gathering deposits as there is a bit of saturation in major deposit collection centres.

In case of lending, the priority sector is already being addressed by small banks as and when they start operations. For non-priority sector lending, the system is currently less willing to lend and prefers government paper.

Besides, RBI is looking at the corporate bond market as being the growing avenue for accessing funds. Against this background, it will be interesting to see how many applications are made for the licence.