On August 11, 2010 the Reserve Bank of India (RBI) put out a Discussion Paper on New Private Sector Banks. After much discussion and debate the RBI, on August 29, 2011, put out the draft guidelines on licensing of new private sector banks and comments have been sought by the end of October 2011. The RBI deserves to be applauded for handling an explosive subject with maturity and astuteness. The whole process of finalising the guidelines, the preparation of applications by aspirants, the granting of licences and the setting up of new banks is going to be such a long journey that those applicants envisaging a rapid gain for themselves would very quickly drop out.

Granting of licences for banks has serious implications for the overall financial sector and the RBI is justified in undertaking a cautious calibrated approach. The whole process for the new banks to be operational may take two to three years.

Promoters' share

After the nationalisation of banks in 1969, no private sector bank was licensed up to 1993. After the 1993-94 round of licensing there was a long pause till 2001 when revised guidelines were issued. After another dormant decade, in 2011 the issue of bank licences is once again under examination.

The draft guidelines for new licences for banks now put out by the RBI envisages eligibility for promoters/promoter groups with a 10 year successful track record. The RBI recognises that as depositors' money is involved it is only appropriate that there should be a comprehensive ‘fit and proper' assessment to ensure that the promoters are not operating in risk prone areas.

The draft guidelines envisage that new banks should be set up only through a wholly owned non-operating holding company (NOHC) which would be regulated by the RBI or other appropriate regulators. There would need to be an arms length operation between the promoter group and the bank.

The minimum capital of Rs 500 crore is low in the current milieu and to set up banks with resilience a higher minimum of say Rs 1,000 crore should be prescribed. The NOHC minimum holding of 40 per cent is locked in for five years.

The excess over 40 per cent would be required to be brought down to 40 per cent within two years from the date of licensing of the bank. This should be a water-tight non-negotiable clause. Invariably, the ‘greed factor' comes into play and the NOHC would persuasively argue for a relaxation of this clause, so that the divestment is undertaken after a much longer time.

Again, the NOHC's shareholding is to be brought down to 20 per cent within 10 years and 15 per cent within 12 years; this stipulation should be cast in stone. The RBI has to be satisfied that the NOHC is ring-fenced and the RBI should be able to undertake a consolidated supervision of the NOHC and the bank.

Tight regulation

For years I have been advocating that corporates should be allowed to enter the banking field with strong safeguards. It is gratifying to note that the present draft guidelines enable corporates to apply. The case for corporates being given entry in to banking is that they would be able to set up strong banks.

The RBI is right to be concerned about ‘self-dealing' by promoter groups and hence the stipulation that a bank would not be allowed to lend to any single group company more than 10 per cent and to the group as a whole not more than 20 per cent of the bank's net worth.

This is a fear expressed by those opposed to corporate entry into banking. It would be best to put a total ban on direct or indirect lending by a bank set up by a corporate to any company connected to the promoter group. The RBI should come down heavily on any mutual compensatory lending between two promoter groups through banks set up by corporates. The stipulation that the new bank should set up 25 per cent of its branches in unbanked rural centres is flawed as a bank can easily set up a tin shed proximate to a metropolitan centre. The stipulation should be the proportion of business in unbanked rural areas.

Gestation phase

It is unfortunate that public sector units (PSUs) are debarred from setting up new private sector banks. To think of it, if PSUs were debarred from setting up private banks in the 1993 guidelines, there would have been no Axis Bank today! The RBI must reconsider this issue.

The final guidelines could take till the end of the current fiscal year. The whole edifice of the guidelines is based on the Amendment of the Banking Regulation Act. Again, the scrutiny of applications by the RBI and the screening by the High Level Advisory Committee could take a year or more. Hence, no new bank is likely to be set up before the end of 2013. Nonetheless, potential applicants would do well to undertake vigorous pre-investment activity.

Death and birth are part of the law of Nature but in India we do not accept that banks should be allowed to die and, as such, how are banks to be born?

(The author is an economist. >blfeedback@thehindu.co.in )

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