New Banking Licenses- A Brief Overview

By Chaahat Khattar

We have been hearing about a common phrase “Reliance, Tata, Birla” from our early childhood. They used to be synonyms for India’s success mantras in business and commerce. Now they are among the 26 high flying conglomerates that have applied for new banking license (TATA though recently withdrew its application). Last time Reserve Bank of India (“RBI”) issued banking licenses, only Yes Bank and Kotak Mahindra Bank got lucky. After 10 long years, RBI has found it prudent to expand the banking sector and this time it seems as if every single is dreaming of venturing into one of country’s most regulated but lucrative sector.

On 22 February 2013, RBI released the guidelines in relation to new banking licenses it plans to allot. RBI has not stated the number of licenses it would be issuing but analysts believe that it should not be more than four. In such a situation, RBI is surely going to have a tough time choosing the best especially when majority of large-scale firms in the country are diversifying and looking out for opportunities.

To make things more interesting, RBI has not restricted any sector or industry to apply for the banking license. As per the norms released by RBI, any private or public company can apply for the license.

Let us summarize the guidelines released by RBI:

Owners/Promoters:

Any Indian group or entity shall be eligible to promote a bank through a wholly owned Non-Operative Financial Holding Company (“NOFHC”). The group/entity certainly should be having sound financial condition, integrity, credentials and must be operational for 10 or more years. The NOFHC will be registered as a non-banking financial company (“NBFC”) with the RBI and will be governed by a separate set of directions issued by RBI.

Broadly understanding, the corporate structure as defined by the RBI norms seems to be fairly simple.  The promoter group/parent company must hold minimum 51% stake in the NOFHC (an individual not holding more than 10% voting equity) and the NOFHC must hold at least 40% voting equity capital in the new bank.

Minimum Capital:

The initial minimum paid up capital of the new bank should be INR 5 Billion out of which at least 40% should be directly held by the NOFHC which can be brought down to 20% after 5 years of the functioning of the bank and to 15% after 10 years.

Capital Adequacy Requirements:

NOFHC along with the bank and its other entities would be required to maintain a minimum capital adequacy ratio of 13% of its risk weighted assets for a minimum period of 3 years.

Foreign Direct Investment (“FDI”):

The FDI in the new banks should not exceed 49 per cent of the paid-up voting equity capital for the first 5 years from the date of licensing of the bank.

Other Miscellaneous Factors:

NOFHC or any of its financial entities should not have any credit and investment (including investment in equity / debt capital instrument) exposure to any entity belonging to the Promoter Group except those held under it. The NOFHC should comply with the corporate governance guidelines as issued by RBI from time to time.

RBI has also stated that the new bank should have at least 25% of its branches in unbanked rural areas with population up to 9,999.

Procedure for Selection:

Broadly there will be only two steps involved:

1. At the first stage, RBI to ensure prima facie eligibility of the applicants will screen the applications. RBI might apply additional criteria to determine the suitability of applications, in addition to the ’fit and proper’ criteria. Thereafter, the applications will be referred to a High Level Advisory Committee to be set up by RBI.

2.The High Level Advisory Committee will set up its own procedures for screening the applications. The Committee will reserve the right to call for more information as well as have discussions with any applicant/s and seek clarification on any issue as may be required by it. The Committee will submit its recommendations to RBI for consideration following which RBI will issue in-principle approval for setting up a bank. Corporates will have 18 months to implement a bank license.

Opportunities:

With a population of over 1 billion, India is undoubtedly a great playground for any business. Banking industry in the country is extremely regulated by RBI and there are severe penalties in case of any misconduct. That is how India has managed to survive global financial turmoil. Hardly any bank in the country has non-performing assets more than 10% of their total assets.

Introduction of private banks have not only made banking accessible for many, it has also turned Public Sector Banks (“PSB”) into aggressive mode with increased efficiency.

Both Yes Bank as well as Kotak Mahindra Bank has ensured that RBI’s decision to issue them license have been rightly justified and both of them are among the top banking firms in the country.     The sentiment among investors is also extremely positive when it comes down to banking sector in India. The banking sector is the largest constituent of India’s total market capitalization at around 25 percent.
The National Stock Exchange’s Nifty banking index, a barometer of banking company stocks, has risen 50 percent in the past one year, belying general economic performance and expectations from the banking business.

Also, demographic shifts in terms of income levels and cultural shifts in terms of lifestyle aspirations are changing the profile of the Indian consumer. The per-capita income in India has crossed INR 5,500 mark that is 11.7% rise over last fiscal, which further increases the need for banking. On the industrial front, the Indian corporates are expanding at an ever-increasing rate with mergers and acquisitions happening all across the globe. Corporate customers are in dire need of more financial institutions to support their high demand for national and international expansion. Finance Ministry with support from RBI has also started testing wholesale debt market and thus, the need for more banks for better access to capital is inevitable. Other factors such as mobile banking, Small and Medium Enterprise (“SME”) banking are also picking pace in the country.

The greatest opportunity that exists is the vast mass of financially excluded people who are waiting to be touched by the formal financial system. The potential benefits to the banking system and to the economy from financially including this segment will be enough to galvanize the economy and restore it back to the high growth trajectory.

Challenges:

India, the second largest populated country, has total 77 banks including 27 public sector banks, 20 private banks and 30 foreign banks. However, this huge universe has not clinched any significant global footprint.

Country’s largest lender - the State Bank of India  (“SBI”) ranks 60th globally in 2012 in terms of Tier I capital (equity + reserves). The second largest bank (in terms of loan book) ICICI Bank  ’s position is way below at 110. Among top 200, only four more banks including HDFC Bank, Bank of Baroda, Canara Bank and Punjab National Bank managed to find their ranks. This leads to a very interesting question. Do we need more banks or bigger banks?

The other point is linked to the condition set for new banks to open a minimum number of branches in rural areas. The problem here is that banks will be more than happy to tap new markets but such markets should at least be accessible.

Banks can lend and accept deposits but there is a need to have sufficient infrastructure for banks to set up rural branches and for rural population to reach the banks.

Agencies such as National Bank for Agriculture and Rural Development (“NABARD”) need to be strengthened and restructured to meet not only demands of the rural population but also financial institutions for the ultimate goal of the government of financial inclusion in the country.

Retail Banking is already flooded. There is an extremely high level of supply when compared to the demand. Earlier the household savings went into banks and the banks then lent out money to corporates. Now banks need to sell banking. It will be interesting to note how new banks create market for themselves and how existing banks offer new services to differentiate themselves.

Closing Note:

RBI is neither deregulating any of the functions or objectives of banking in the country nor introducing a modified banking methodology. RBI is moreover giving opportunities to cash rich corporates to reinvest their funds in India only instead of parking them outside. Adding more banks in the country might not bring an revolutionary change in the skewed financial sector of the nation but if new banks keep profit maximization as their secondary objective then they will be on the right track of socially and economically uplifting the ignored population of the country which is the prime motive of RBI as well as the on going 12^th Five Year Plan. One thing that is very sure is that RBI will not easily allow banks to exploit the markets to swell their balance sheets. The way it has set norms and guidelines for the new banks and witnessing RBI’s perfect hold over banks of the nation, from a wide perspective the new banks should be well in interest of the investors as well as borrowers. Though Indian banks had exposure to economic turmoil but none of them went under cash crunch possible just because of regulatory credit requirements monitored and regulated by RBI.

Raghuram Rajan right after his appointment as RBI’s Governor has indicated that RBI will issue the new licenses sometime around January 2014. With Basel III norms being introduced by RBI in India coupled with it’s zestfulness to issue new banking licenses, RBI is on a boost mode to help the economy grow motivated by better investment opportunities and sufficient availability of credit in the system. It will be interesting to observe which billionaire manages to get hold of the sought after banking license and whose automated teller machine sets up few meters away from your home. We believe that IDFC and LIC Housing Finance are the top contenders for the banking licenses taking in view the relevant experience both these firms have and where one firm is hopeful to benefit the much needed infrastructure development and the other being part of country’s largest custodian of equity investments.

---

Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at ckhattar@gmail.com