On February 22, 2013, the Reserve Bank of India released the final guidelines for licensing of banks in the private sector on the basis of important amendments in December 2012 to the Banking Regulation Act, 1949, suggestions and comments received on the draft guidelines, and in consultation with the Ministry of Finance.
Selective Licensing
Although the guidelines are open to allowing non-banking financial company (NBFC), private sector entities/ groups and public sector entities in the banking arena, it is clear that the RBI will be very selective in issuing new licences. Also, prior experience shows that the RBI has gradually become more stringent in the issue of licences. The guidelines foreshadow the fact that banks promoted by certain groups could potentially expose the bank to risks associated with ‘group activities such as those that are speculative in nature or subject to high asset price volatility’.
The RBI, in this round of licensing, seems largely focused on entities that have
an ability to build a differentiated and viable model that balances financial inclusion and profitability;
access to capital and management resources for building a sustainable banking business.
Corporate restructuring
The RBI has defined a wholly-owned Non-Operative Financial Holding Company (NOFHC) structure, which will hold the bank as well as all the other financial services entities of the group, with the intent of ring-fencing the regulated financial activities. The NOFHC should be registered as an NBFC and will be governed under separate rules.
Any NBFC wishing to convert or promote a bank should transfer to the bank all existing businesses that can be undertaken departmentally within a bank. However, certain activities such as credit cards, primary dealers, and so on can be carried out either within the bank or through an outside structure (subsidiary/ joint venture/ associate).
NBFCs have played a complementary role to banks in the country’s overall financial system. The NBFC sector has filled a crucial gap in supplying credit to retail customers in rural and semi-urban areas and relatively under-served segments, whereas commercial banks have largely focused on large corporates and retail credit. Today, NBFCs have built sound capabilities around underwriting norms, penetrative market knowledge, cost-effective operations and highly personalised customer service. Thus, the entire proposition of NBFCs converting into banks, or forming a bank and transferring activities that can be undertaken departmentally or through a separate entity, will need to be carefully evaluated.
An important guideline for NBFCs wishing to convert into a bank stipulates that conversion of branches in Tier 2-6 locations is automatic, whereas conversion in Tier 1 locations are subject to RBI approval, as applicable for private sector banks.
The way forward
The guidelines on structure are expected to create complex issues, especially when restructuring businesses and aligning shareholding under the NOFHC. Moreover, when transferring existing NBFC and other financial services businesses under the NOFHC, promoters may need to inject additional capital.
NBFCs also have the option of transferring other financial activities (not permitted to banks) to other entities under the NOFHC, or divesting those activities. This may eliminate the regulatory flexibility that NBFCs currently enjoy. To execute their plans for entry into the banking sector, corporates, including NBFCs, should watch out for the release of
the overall policy discussion paper on banking structure in India, scheduled end of this month;
separate directions from the RBI, governing the NOFHC registered as an NBFC;
final report on the introduction of the Financial Holding Company Act.
The author is Partner, Financial Services, KPMG in India