RBI’s On-tap licensing : Introducing a transparent and competitive approach to banking

A police officer stands guard in front of the Reserve Bank of India (RBI) head office in Mumbai April 17, 2012. The Reserve Bank of India cut interest rates on Tuesday for the first time in three years by an unexpectedly sharp 50 basis points to give a boost to flagging economic growth but warned that there is limited scope for further rate cuts. REUTERS/Vivek Prakash (INDIA - Tags: BUSINESS)

The Reserve Bank of India, earlier this month, issued the Draft Guidelines for ‘on tap’ Licensing of Universal Banks in Private Sector, which seek to put an end to the existing ‘Stop and Go’ licensing policy. What this means is, banks can now apply for a license (instead of waiting for a decade) at any time provided they meet the ‘fit and proper’ criteria.

Manisha Shroff, Associate Partner at Khaitan & Co says,

The draft guidelines do evince the RBI’s intention to diversify the banking sector and introduce a transparent and competitive approach to licensing of private banks, the eligibility conditions continue to be quite stringent and new entrants may find them daunting.

The guidelines pave the way for existing NBFCs to enter the banking system formally which may be a step towards greater efficiency and competitiveness.”

Background

Since 1991, the size of the Indian economy in terms of GDP at market prices has increased by almost fifteen times, whereas the household financial savings have expanded by sixteen times and the gross domestic savings by almost seventeen times during the same period. The banking system needs reformation in order to address the needs of this dynamic economy. It also needs to be made more flexible and competitive. From the financial inclusion perspective too, there is a pressing need to extend the reach of financial services to the excluded segments of the society.

It’s a widely held view that private banks are more profitable and efficient than PSBs. As reported hereIndia’s government-owned banks, which account for about 70% of assets, will lose their market share. A pile of bad loans, lack of capital and inefficient board and top management in some cases, among other things, will shrink business opportunities for them. Which is why both the government as well as the banking regulator have been pushing for consolidation among public sector banks. Interestingly, many foreign banks too have lost their way in India.

Universal Banks

Universal banking represents a combination of the two pure banking models viz. commercial and investment banking. The shift towards universal banking has been on account of perceived economies of scale and scope leading to increased economic efficiency. Universal banks provide a wide array of services such as loans, deposits, asset management, investment advisory, payment processing, securities transactions, underwriting and financial analysis.

Stop and Go Policy

While foreign banks are already allowed continuous authorization, for domestic aspirants, RBI opens the window for bank licenses periodically but rarely. The Stop and Go policy inevitably leads to a ‘frenzied’ response from large number of competing aspirants, whenever the licensing process is opened up in an ad hoc manner.

Thus, “by giving licenses once in a decade, some kind of artificial scarcity gets created, as if some kind of rationing is going on, and it indeed attracts all kinds of frenzied activities”, said Naresh Makhijani, a partner at consulting firm KPMG in India.

The last round of licenses was given out in 2003, and before that in 1993.

Continuous Policy

With a view to liberalise the entry process in the banking segment, what the draft guidelines propose is a continuous authorisation process which will allow domestic aspirants to continuously apply for bank licenses provided they meet the criteria specified.

Liberalising the entry process will inter alia put competitive pressure on the existing banks and hopefully improve their performance, and also bring (new) technology and ideas into the banking segment.

Differentiated license

Differentiated licenses allow the banks to operate in certain niche areas (wholesale banking, retail banking and infrastructure banking). This means, differentiated licenses will be issued to banks specifically outlining the activities the licenses entity can undertake. Countries like USA, Australia, Singapore, Hong Kong and Indonesia are some jurisdictions which are practicing differentiated licenses.

In 2015, 10 banks were granted ‘small finance bank’ licenses and 11 banks were granted ‘payment banks’ licenses by the RBI.

The Guidelines

While big corporate house have long dreamt of owning banks, the guidelines have, in a single stroke, quashed those dreams by disentitling private sector entities, having assets worth Rs. 50 billion or more, who derive over 40 % of their income from non-financial business. Such entities have been referred to as ‘large industrial house’ and will not be eligible for on-tap license.

This means top business houses like Tatas, Ambanis, Bajajs and Mahindras will most likely, not be eligible for this license. The only consolation provided to the ‘large industrial houses’ is that they are allowed to ‘invest’ up to 10 percent in the equity of the bank, as compared to the erstwhile 5%. However, such entities cannot have a Director on the Board of the bank. To this Shroff adds,

This exclusion does not come as a big surprise as the RBI has historically been reluctant to allow diversified business conglomerates to promote banks – this policy appears to stem from a need to preserve the independence of the banking sector and keep it free from undesired influence and corruption.

The Draft Guidelines want all ‘fit and proper’ candidates to float banks, bidding adieu to a repressive financial system. Thrust has been laid on the control falling under ‘residents’ of India. According to Manisha Shroff,

The thrust on control by residents may stem from a need to avoid exposure to risks generated in the home jurisdictions of the foreign banks.”

The guidelines predominantly favour entities engaged mainly in financing activities (such as NBFCs) having 10 years of experience

Further, promoters, be it individuals or entities, are more or less subjected to the same conditions with the focus remaining on ‘10 years experience’ even here.

While individuals or standalone promoting entities need not have a Non-Operating Financial Holding Company (NOHC), it is mandatory for promoter entities having other businesses. 51% of total voting equity shares of the NOFHC shall be held by promoter/s / companies forming a part of the promoter group

The NOFHC is formed with a view to insulate the regulated financial services entities of the group from other activities of the group.

The NOFHC, which will be registered with the RBI as an NBFC, will hold the bank as well other financial services companies of the group. Such NOFC shall not be permitted to set up any new financial series entity for at least three years from the date of commencement of business of the NOFHC

The capital requirements appear to a bit onerous. With the minimum paid-up voting capital being set at Rs. 5 billion, right from the beginning till perpetuity, many-otherwise eligible entities- could face hurdles.

The promoter/s and the promoter group/ NOFHC, as the case may be, shall hold a minimum 40% of the paid-up voting equity capital of the bank which shall be locked-in a for period of 5 years from date of commencement. This holding is to be brought down to 30% in 10 years and thereafter 15% in the next 2 years.

Further, no entity other than promoter/ NOFHC is permitted to have more than 10% holding.

Prudential and exposure norms

Banks must comply with provisions of Banking Regulations Act, 1949 and the existing guidelines on prudential norms as applicable to scheduled commercial banks. The bank is precluded from having any exposure to its promoters, major shareholders who have shareholding to the extent of 10 per cent paid-up equity shares in the bank, the relatives of promoters as also the entities in which they have significant influence or control.

 Other conditions

  • The Bank shall get its shares listed on the stock exchanges within six years of the commencement of business by the bank.
  • Residents should control bank at all times.
  • At least 25 per cent branches in unbanked rural centers (population up to 9,999 as per the latest census)

Procedure for application

The RBI will do a preliminary screening to check if the applicants meet the criteria laid down in the guidelines and upon satisfaction, will forward to an external committee for its recommendations. However, a time frame for the process is desirable, as Shroff notes,

A key change that could be made is in terms of a precise time-bound approach being adopted for screening and processing of the applications for licensing, as the uncertainty regarding the time required for approval of an application was noted from the Bandhan and IDFC experience, where the licensing process itself took more than 4 years.