This Monday, two documents were released which would have a long and deep impact on India’s financial services industry.
The working group’s report on issues among non-banking finance companies (NBFCs) indicate the direction of evolution for this sector. While the Reserve Bank of India’s draft guidelines for licensing of new banks in the private sector provide a direction for those aspiring to participate in that sector. For the next several days, these documents will be read and re-read for a full comprehension of the basis and background of the conclusions.
With the draft guidelines, RBI has set the ball rolling on getting entrants into the Indian banking industry. Ever since the announcement in the 2010-11 Budget speech, followed by a discussion paper in August 2010, much has been said but much is yet to be said on this subject, while much has also been left to the regulatory prerogative.
From a macro perspective, RBI has directionally signalled two things. One is to permit Indian business groups to enter banking, but only those very suitable and who are prepared to meaningfully contribute to financial inclusion. Two, allowing NBFCs to convert into or set up banks, sans any potential regulatory arbitrage between the proposed banking and their existing ‘banking-type’ businesses.
Overall, this is a well balanced approach to ensure the regulatory and governance concerns are adequately addressed, without stifling the enthusiasm of business groups and NBFCs.
The regulator’s strong focus on financial inclusion is apparent in the draft guidelines, reflected particularly in the stipulation of opening at least a fourth of branches in unbanked rural centres. One school of thought is that this will be disadvantageous for new banks on account of the potential high cost of service/credit delivery and lower productivity. On the other hand, this also presents an opportunity in a market segment where the existing players have hitherto met with limited success. Aspirants will need to focus strategies to convert this predicament into a competitive advantage.
For this model to be successful, it is imperative to widen financial literacy in rural areas, provide easy access to the population and offer products/services that are easy to understand. Also, leverage technology to drive down costs and piggy-back on various government initiatives, such as the Unique Identification (UID) programme. Large Indian business groups possess the ability to commit the skills required for the required scale of operations, pertinent to pursue financial inclusion. There is no doubt that financial inclusion of any consequential measure will require a joint initiative by the government, the regulator and the industry. Interestingly, several well established NBFCs may be at a particular advantage, given their experience in the business of lending and entrenched rural reach.
The draft adequately addresses the risks and concerns emanating from the participation of industrial/business groups in the banking sector. As in the aspects related to corporate structure, governance and operating model, notably the non-operative holding company (NOHC) structure and the need to maintain a higher capital ratio at 12 per cent. Ring-fencing of all financial service businesses of a group by bringing these under the NOHC and a five-year lock-in of promoter holding would deter aspirants looking for short-term benefits.
To ensure the new bank is not treated as a ‘captive’ funding institution by the parent group, single and group credit concentration limits have been proposed. Much of these are on expected lines, given that banking is one of the most sensitive sectors of an economy and carries the potential to inflict devastating systemic consequences, if not governed properly.
Certain aspects of ‘checks and balances’ may not have been articulated very clearly, such as the meaning of diversified ownership. Further, the premise of misalignment of all broking activities from banking may not be entirely accurate. There may be a case to consider applications of brokers who operate purely on an agency model. Clear segregation of ownership and management, along with regulatory pre-approval for appointment of directors on a bank’s board, should adequately address the concern of unsuitable and improper participation at board level.
Although there is the requirement to segregate ownership and management, there have been Indian examples of professionals successfully owning and managing businesses, including banks, with high level of good governance. Depending on the capital market conditions, the requirement to ‘go public’ within the first two years may be sub-optimal.
Perhaps the intent is to leave the guidelines broad-based, so as to dissuade the prospective applicants from finding creative ways to meet compliance while at the same time allowing the regulator to exercise qualitative discretion. In summary, this draft is a promising initiation and as the prospective applicants eagerly await the release of final guidelines over the coming months, it is clear the gates have been opened for a large number of business groups and NBFCs, but stringent eligibility criteria, rightfully, demands that only the steadfast will succeed.
The author is Director, Ernst & Young India. The views are personal