The risks, in the current context, may outweigh the benefits with regard to the Reserve Bank of India’s commercial bank licensing policy, according to the joint IMF-World Bank Financial Stability Assessment Programme (FSAP) for India.

The legal, operational, and regulatory framework for consolidated supervision of both bank-led groups and financial conglomerates is still missing some important elements, it said.

Gain experience first

“It would be prudent to first put in place (these important elements) and gain sufficient experience from implementing a comprehensive framework for this purpose before even considering whether to proceed with the entry of mixed groups and conglomerates (in the banking sector),” said the FSAP.

In 2011, the RBI issued guidelines for a new window of bank licences with the stated objective of issuing a limited number of new licences to foster competition; reduce costs; improve service; and promote financial inclusion.

The key difference with past policy in the RBI’s guidelines for bank licences in the private sector is the express eligibility of large industrial houses to promote new banks; or to convert non-banking finance companies (NBFCs) they own into new banks.

Industrial houses

FSAP underscored the fact that international experience has supported the prudent policy position of disallowing industrial houses from promoting and owning banks.

It pointed out that consolidated supervision frameworks and capabilities are weak even for bank-led groups in majority of the jurisdictions assessed under the FSAP, and frameworks for the oversight of financial conglomerates continue to be a “work in progress” at the international level.

According to the FSAP, even greater complexity is introduced in supervisory frameworks when a significant part of the group (intending to float a bank) is engaged in non-financial activity, the risks of which are not well captured by current supervisory frameworks. This may lead to concerns of ‘under the radar’ risk transfer; concentration of risk exposures; and contagion across the group.

Prudent steps

The RBI policy on new banks acknowledges the above risks and aims to address them through several prudent means: promoters with greater than 10 per cent income from assets in volatile sectors such as real estate and brokerage are not eligible for promoting a bank; and a non-operating holding company, which cannot be leveraged, must be set up to hold all the financial entities in the group and in turn be supervised by the RBI as an NBFC.

Further, 50 per cent of directors (increased to a majority in some cases) must be independent of the promoter; and the bank, group entities, non-operating holding company, and the promoter would be subject to RBI’s consolidated supervision.

>Ramkumar.k@thehindu.co.in