Dilemma over bank licences: NBFCs struggle to make the cut for RBI's rules

The IL&FS crisis came as a rude shock to those who thought circumventing regulations could be a blueprint for the lending business in India. India is a credit-starved country — banks’ total assets account for less than 70 per cent of GDP — so it’s not difficult to be successful as a non-banking financial company (NBFC).

The catch here is accessing funds. Where do NBFCs source their money? The biggest source is commercial banks, which the IL&FS crisis of 2018 choked off. The apparent silver lining was that in August 2016, the Reserve Bank of India (RBI) had opened the tap for universal bank licences, later extended to small finance banks (those that can provide basic services of lending and deposit-taking to small borrowers such as micro-businesses and marginal farmers).

No one celebrated, though, because bank licensing rules have caveats. One of them is that entities that derive over 40 per cent of their revenue from non-financial activities are not eligible for the race. That closed the door for large corporate houses. A year-and-a-half ago, the regulator rejected a recommendation by an Internal Working Group, which it had set up to review ownership norms of private sector banks, that industrial houses should be considered for bank licences.

That, then, leaves NBFCs in the running. Since the 2016 announcement, there were 11 applications for licences — four for universal banks and seven for small finance banks. Recently, the RBI came out with a list rejecting all four applications made for setting up universal banks, and two out of the seven applications for small finance banks. Five applications remain in contention for small finance banks (see box).
 

The rejections included Flipkart co-founder Sachin Bansal’s Chaitanya India Fin Credit Pvt Ltd, which had applied for a universal bank licence.

The RBI did not specify why these applications were rejected, but R Gandhi, former deputy governor of the central bank, explained, “The RBI analyses the applications that come under on-tap licensing on several parameters such as if the promoters are eligible under the fit-and-proper criteria; if the business model is conducive; if they have the ability to raise capital and so on. It wants applicants to have a high threshold on all the parameters.”

Gandhi pointed out that the “RBI has always been conservative in giving bank licences but that does not mean it is against it. Last time when the central bank received 12 applications, only two were granted licences — Bandhan and IDFC.”

So this poses a dilemma. An entity may have become successful as a microfinance lender or as a consumer loan business. Why risk applying for something where even rejection can raise reputational and future fund-raising risks?

The entities that are still in contention for small finance banks are: Tally Solutions Pvt Ltd — a technology and innovation company famous for its eponymous accounting software; Cosmea Financial Holdings, run by former Reliance Capital CEO Soumen Ghosh; West End Housing Finance, an affordable housing finance lender; and Dvara Kshetriya Gramin Financial Services Pvt Ltd, a private trust that facilitates access to financial services to rural India; and one Akhil Kumar Gupta.

It is uncertain how many of them will receive the RBI’s in-principle approval.

Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services, who advises several NBFCs on the licensing process, said, “The RBI’s fit-and-proper criteria for promoters of entities seeking universal banking licences is very tight and rightly so.”

To be sure, over 2014-16, the RBI granted 23 bank licences. Two of them were universal bank licences, 10 small finance bank licences and 11 payments bank licences. How these new entities have performed is a matter of debate, however. There have been some bank failures in recent years, Yes Bank and Lakshmi Vilas Bank being notable ones.

“The RBI does not appear to be eager to grant banking licences just for the sake of increasing the number of banks in the country. Instead, it wants the existing banks to have large balance sheets,” Parekh pointed out, adding, “The rejections also make sense in the context of the recent failures in the banking system and the new ones that were granted licences not performing that well. So, the RBI is apprehensive of a new entity coming in and later struggling.”

As a result, the question of whether industrial houses should be allowed in banking has stayed in contention. The RBI’s position is: Given that banking is a highly leveraged business dealing with public money, it makes sense to keep industry/business and banking separate.

But Sanjiv Bajaj, chairman, Confederation of Indian Industries (CII), and managing director of Bajaj Finserv, one of the country's largest NBFCs, recently told Business Standard, “To build an Atmanirbhar Bharat, we first need an atmanirbhar (self-reliant) financial services industry. The RBI already has a definition of who it would allow or not allow (to own banks). I feel good-quality players should be allowed. We are seeing many strong NBFCs that have built good capabilities over the long term and have shown their resilience, and they could be encouraged to move towards a bank licence.”

However, as Gandhi pointed out, just because the RBI has been rejecting most of the applications in the last few years doesn’t call for allowing corporations into banking. “That would mean a policy change on the RBI’s part, which, I presume, the RBI is not comfortable with. Although I, personally, feel that corporations should be allowed into banking,” he said.

The RBI has also tightened guidelines, narrowing the regulatory arbitrage that existed between NBFCs and banks. NBFCs now have liquidity requirements and have been brought on a par with banks regarding bad loan classification rules.

This regulatory tightening prompted HDFC Ltd to merge with HDFC Bank. This move by India's largest housing financier has begged the question whether other large NBFCs will look to do the same. Experts believe that the merger will not encourage other NBFCs to convert into banks because the nature of the businesses are different.

“There are certain customer segments that banks do not lend to for lack of reach and understanding. So, as long as there is a vacuum in these market segments, NBFCs will thrive,” Umesh Revankar, VC and MD, Shriram Transport Finance, told Business Standard earlier. So, NBFCs are not a competitor to banks; rather they are complementing banks in reaching these credit-starved segments and geographies, he added.

“To become a bank one needs to have the expertise to manage the liability [deposit] side, given that you will be managing public money. And, many NBFCs would not want to do that. So, I don’t think NBFCs should convert into banks just because the regulatory arbitrage has come down,” Gandhi added.

So, for NBFCs, the dilemma of applying for a banking licence remains.