Don't get carried away by RBI's paper

Last Updated: Sun, Aug 15, 2010 19:40 hrs

The Reserve Bank of India’s (RBI) discussion paper on entry of new banks in the private sector is yet another policy soliloquy published by India’s central bank on the subject. This one would qualify as the best-written one so far, but one should not build too much hope reading into the RBI’s mind, which is seemingly open to possibilities hitherto considered anathema.

For a nation of a billion people, the shallowness of banking penetration is apparent – unless, the confusing statistics have been misread by this column, on an average, one branch of a commercial bank services just about 15,000 people. While promotion of financial inclusion through deeper competition is the mantra cited by the RBI to justify its intent to issue new "limited number"of bank licenses, one hopes this is not just a buzzword.

The RBI has won accolades for protecting India from the shocks of the international financial system – a phenomenon largely attributable to being conservative.

A parent that does not allow her child to run around much would indeed have a better track record in minimizing injury to the child. However, in a candid confession, the banking regulator has acknowledged that its policy on new private sector banks does not have much to show. Specifically, three banks have had to be merged with other in stressful circumstances, banks promoted by individual banking professionals have "failed or merged with other banks or had muted growth," and four institution-promoted banks have merged into their parents, converting their parents into banks.

Therefore, utterances in the discussion paper on participation by industrial houses in banks are leading to surprise and avoidable speculation. But it is unlikely that the RBI would change its mind on this aspect despite the loud thinking. The listing of "cons" by the RBI in this regard being far longer than that of "pros", and the suggestion that industrial houses may be permitted to set up regional rural banks, would mean that the RBI is unlikely to allow much change here.

Even if ordinary industrial houses are indeed permitted to have large stakes in banks, the conditions imposed may be so stringent that they may find it unattractive to invest. Besides, the industry groups that were then ignored in favour of individual professionals in 1993 may no longer be as interested in running banks, considering how stringently the operation and sale of a commercial bank has become. Moreover, most large industry groups that wanted banks and finance companies primarily for financial clout have set up their own "private equity"businesses to achieve the same objective.

Although the discussion paper strives to hide the RBI’s mind by setting out multiple options on every issue, with pros and cons for each option, one clear takeaway is that the minimum capital requirement for new banks would be increased from the level of Rs 300 crores. It seems clear that the RBI would prescribe a higher entry threshold of say, Rs 500 crores with an obligation to increase the capital to Rs 1,000 crores over a period of time. Failure to enhance the capital would then lead the RBI to pushing the defaulting banks to merge with others – clearly the approach of the regulator in the last ten years.

The much-debated issue of capping shareholding in banks has been debated again, with the RBI pointing out that in most jurisdictions, the central bank or some other government authority plays God. Besides, the RBI seems clear that a shareholder that is itself not a widely diversified owner, would not get to hold a large stake in a bank’s capital.

The Banking Regulation Act, a law passed by Parliament leaves little wiggle room for loosening the lack of de jure control in the hands of shareholders of banks. Despite such law, the de facto control historically wielded by substantial shareholders would result in the RBI’s regulations remaining stringent.

There is one scary suggestion in the paper. The document says: "Since the objective is to create strong domestic banking entities… aggregate non-resident investment…in these banks could be capped at a suitable level below 50 per cent and locked at that level for the initial ten years". Today, commercial banks such as ICICI Bank and HDFC Bank have foreign ownership to the fullest extent – almost 74 per cent. There is little reason to limit foreign ownership in newer banks alone to less than a majority.

Such an artificial barrier would lead to over-pricing of the shares (too short a supply of paper for a widespread demand for equity in Indian banks), artificial restriction on access to capital by these banks, and a two-toned regulatory framework within the same banking system. In fact on no licensing aspect should there be a two or more shades of regulatory colour for the same subject.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)


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