Salient Features of Draft Guidelines for New Banking License, recently issued by RBI

Reserve Bank of India has issued its Draft Guidelines for issue of new bank licenses in India in the private sector. In a circular issued on 29 August 2011, RBI has invited comments from various stakeholders. Final guidelines will be issued after receiving feedback from the public and subject to some amendments to the Banking Regulation Act. RBI has been moving very cautiously with regard to issuing new bank licenses. In the last two decades, RBI has issued only 12 new bank licenses. It is of the opinion that its experience with the promoters of new private sector banks is not up to the mark. Another issue that is bothering the RBI is the corporate structure of the new banks as well as the existing banks. Now, banks have become financial conglomerates offering a bouquet of financial services, like, banking, insurance and broking – all less than one roof. These services are coming under different regulators, like, SEBI, IRDA, stock exchanges, and PFRDA. The challenge for the RBI is to have a full regulatory control over these financial conglomerates and to sort out any differences among the regulators backed by strong legislation.

What are the salient features of the RBI’s Draft Guidelines? Initial Capital: The minimum initial capital shall be Rs 500 croreØ Eligible Promoters: Promoters should be resident Indians with aØ minimum successful track record of 10 years. Ownership and management should be different in the promoter group that owns the new bank. However, promoter groups which have 10 per cent or more income from real estate, construction or broking will not be eligible for the new bank license. NBFCs: Existing Non-Banking Finance Companies can convert themselves into banks or apply for a new banking license Corporate Structure: Promoters have to set up a wholly-owned non-operative holding company (NOHC). This NOHC will hold the new bank as well as other financial services companies, like, life insurance, general insurance and others. Foreign holding: Total foreign holding from FDI, FIIs and NRIs cannot exceed 49 per cent of the total stake for the first five years. Currently, the total foreign shareholding in private sector banks cannot exceed 74 per cent of the paid-up capital. Fifty per cent of directors in the bank’s board shall be independent All applicants shall submit their business model to RBI while forwarding their applications The new bank shall get itself listed on a stock exchange within two years Minimum capital adequacy is 12 per cent for a minimum period of three years The bank shall open at least 25 per cent branches in unbanked rural centres How many licenses may be issued by RBI? Many entities have been waiting in the wings for a banking license. However, RBI may issue a maximum of only five to ten licenses.

Who are the likely aspirants for the licenses? The following entities/promoters may seek new bank licenses: Tata group Aditya Birla group (Kumar Mangalam Birla) Bajaj Finserv (of Bajaj Auto) Reliance Capital (of Anil Ambani) L &T Finance Holdings (of Larsen & Toubro) MahindraØ & Mahindra Sundaram Finance IFCI Limited SREI FinanceØ However, groups, like, Religare and IndiaBulls may not be eligible for the new bank license as RBI is not in favour of issuing bank licenses to promoter groups connected with construction, real estate or broking activities.

When are the new bank licenses likely to be issued by RBI? RBI has issued only draft guidelines now and it will take another fiveØ to six months to issue final guidelines. Overall, it may take another one year from now for RBI to actually issue any new bank license.

What are the amendments needed for the Banking Regulation Act? Before issuance of new bank licenses, RBI has stated that the following amendments, inter alia, are required before issuing any new bank license: Removal of restriction of voting rights Empowering RBI to supersede the Board of Directors of a bank so as to protect depositors’ interest; and Facilitating consolidated supervision.

Who will benefit once new bank licenses are issued? Banking is yet to see its full potential in India. New bank licenses will increase the reach of the banking in India. Banking services will increase in depth and variety. This may ultimately benefit the existing as well as new customers. Banking services play a pivotal role in a developing economy and may strengthen the financial services sector in India and thus increasing India’s national income.

What is the Background? The Finance Minister made an announcement of issuing new bank licenses in his Union Budget speech in February 2010. Following the FM’s announcement, RBI released, on 11th August 2010, a discussion paper for issuing new bank licenses. These Draft Guidelines have now been issued after receiving various comments and suggestions from various parties and consultations with the Government of India. Licenses for ten private sector banks were issued based on the RBI Guidelines of 1993. These banks, include, ICICI Bank, IDBI Bank (merged with IDBI Limited in 2005), HDFC Bank, IndusInd Bank, UTI Bank (now Axis Bank), Times Bank (merged with HDFC Bank in 2000), Global Trust Bank (merged with Oriental Bank of Commerce in 2004), and Centurion Bank (merged with HDFC Bank in 2008). Licenses for another two private sector banks – Kotak Mahindra Bank and Yes Bank – were issued in 2003/2004 based on the RBI Guidelines of 2001.

Raising the bar (Editorial from The Hindu )

The Reserve Bank of India took a measured step towards licensing new private sector banks by releasing a set of draft guidelines on Monday. The central bank's concerns on licensing-related issues have been evident right from the time the Finance Minister mooted the idea in his February 2010 budget speech; unsurprisingly, these find expression in the guidelines. Allowing private players to start banks has always been a sensitive issue in India's recent history. More so when it is seen to benefit large industrial houses and business groups, whose questionable practices in banks they owned were one of the justifications for bank nationalization that began in 1969. RBI Governor D. Subbarao was airing a widely held apprehension when he said recently that the “gaps” in the existing regulations could lead to corporations “self-dealing” in banks they promote or using them “as a private pool of readily available funds.” The limited attempts at licensing new private banks through guidelines issued in 1993 and 2001 do not offer any valuable lesson for current policy making beyond the quite obvious fact that only banks with sound promoters do succeed. The RBI has therefore done well to insist on “sound credentials”, “integrity”, “diversified ownership” and a 10-year track record. Prospective promoters should not have even a 10 per cent exposure to real estate and broking businesses. That is ostensibly meant to keep out those from “speculative” sectors. The stipulation that a new bank can be set up only through a wholly owned non-operative holding company is an important safeguard designed to ring fence the bank and its depositors from problems in related entities. Necessary amendments to the Banking Regulation Act 1949 will be carried out to remove the restriction on voting rights while concurrently empowering the RBI to approve acquisition of shares/voting rights of 5 per cent or more by persons who are “fit and proper.” The RBI will get sweeping powers, for instance, to supersede the bank's board in certain cases. The minimum capital requirement is fixed at Rs.500 crore and the capital adequacy ratio at 12 per cent. New banks will have an up-to-date technology platform from day one and ensure that every fourth branch is located in rural areas. Furthering financial inclusion is one of the main reasons for licensing new banks. It is likely that only a small number of applicants will qualify and fewer still will be able to get the licence from an RBI-appointed expert committee. The central bank has said that silences will not be issued to all those who qualify. It is clearly not about to open the floodgates.

Conclusion

The amendment to Reserve Bank of India's new Licensing policy for the opening of new bank branches is a good move provided it paves way for an economy which is viable and the banks still customer friendly. This amendment is a further simplification of the earlier commitments which the Finance Minister has told in the parliament on 31st. March, 2010. The minimum capital required for starting a new branch is also a welcome measure which can lead to branches opened at many places. The Central Bank's guidelines for the wholly-owned NON - OPERATIVE HOLDING COMPANY registered with it is a good move. Further requirement of 25% of branches in rural areas is also a boon to the industry and promotes banking to the down-trodden of the society. Over all it is a welcome move.

For financial inclusion, banks’ network has to go rural. We all know that it takes quite a few years to make operations of bank branches profitable in semi-urban and rural areas and hence all banks, whether in the public sector or private sector are not at all eager to go rural. In all likelihood, therefore, new bank licences may not serve the objectives of enhancing the financial inclusion and widening the banking network. In this connection it may be pointed out that to increase the rural telephone and broadband network, the Union Ministry of Telecom has set up a fund called Universal Service Obligation Fund, a similar fund can be set up to meet initial losses of newly opened branches of banks in semi-urban and rural areas.

Abbreviations: SEBI – Securities and Exchange Board of India, IRDA – Insurance Regulatory and Development Authority, PFRDA – Pension Fund Regulatory and Development Authority, FDI – Foreign Direct Investment, FII – Foreign Institutional Investor, and NRI – Non-Resident Indian.

Sources: RBI website