Banks in India: Too few to fail

Joseph Schumpeter saw credit creation and its contraction as being at the heart of capitalism. In India credit growth has remained anaemic even as we have maintained social distancing from market-linked reforms. BIS data shows that India’s credit to the non-financial sector as a percentage of its gross domestic product (GDP) has consistently lagged, but now it seems to be stuck in a rut. Consequently, growth too has remained anaemic.

To get growth back, India needs to revive the animal spirits that fuelled the economy in the early years of this millennium and to move money from those who don’t need it today to those who can benefit from its access. The banking sector does this best. Forget the health of the banks, what should be worrying the regulators is just the number of banks through which such financial intermediation can take place. 

After the next round of public sector bank (PSB) mergers, I can count just 15 or so banks of any meaningful size and even fewer with the balance sheet to meet the economy’s needs. You can increase this tally by totalling foreign banks, small finance banks,  urban and state co-operative banks, and regional rural banks, but with approximately 10 per cent of the banking sector’s assets, these will not move the needle on credit creation. And most are too small to survive.      

We need to quickly increase the number of banks in the system: We need to license more.  
 

The quickest way will be to convert non-banking financial companies (NBFCs) into banks, for which the Reserve Bank of India (RBI) needs to establish a “glide path”. Ashish Gupta of Credit Suisse advocates that the moment an NBFC’s asset size crosses a threshold — as  a percentage of outstanding total credit —  it can apply to become a “small bank”, and on reaching the next threshold, a “universal”. The pain of meeting the reserve requirements may hold NBFCs back from converting, unless the RBI gives a liberal time frame for full compliance. “The RBI should think of conversion to a bank as not just a ‘privilege’ but a ‘cost’ as well,” says Gupta. He advocates that reserve requirements kick in for NBFCs as they grow — albeit beginning as a smaller percentage and ratcheting-up as the NBFC gathers heft. This implies that the cost of remaining an NBFC will be higher for those that choose not to become a bank. In his view, the RBI facilitating conversion of large NBFCs/housing finance (HFC) companies to banks will improve financial sector stability as they migrate to a more stringent regulatory/supervisory regime and also more diversified and stable funding sources.  

You can extend the same reasoning to converting co-operative banks to “regular” banks. 

 

 

Such conversions have advantages. First, you can jump-start bank licensing and quickly have more banks of scale in the system. Second, these entities have an established track-record, built on the back of reasonable underwriting practices; they have been lending and more importantly recovering money over the years: Survival instincts should be lauded, not questioned. Third, the RBI struggles to regulate NBFCs and co-operative banks. This will help.

The question of what to do when dealing with NBFCs that form a part of a business group is still unanswered. I favour it with regulatory guardrails but this needs greater debate. 
 

The last time around when a few NBFCs applied for a licence to convert themselves into a bank, the RBI wrote to other regulators seeking feedback. It is difficult to argue not too. But in doing so, the RBI must be mindful that “retail” complaints will always be there — be it brokerage charged, execution of trades or sale of insurance policies. Unless there is a systemic issue, these should not be the basis for denying a licence. Further, let the other regulatory and judicial bodies respond in a time-bound manner, classifying transgressions, if any, as serious (enough to deny a licence), wrap on the knuckles ( a fine) or to be condoned (do nothing). Also, with the RBI being the primary regulator, for NBFCs (and now HFCs as well), the ball is in its court. 

There are issues like minimum share capital, ownership and voting, bank holding companies, globally successful bankers starting banks in India and a host of other matters. And we can imbibe lessons from bank failures. But for each example that can be offered to support a point of view, another can be proffered showing the opposite being equally true. The extensive debates on various issues and a listing of bank failures should be used to better regulate banks, not to strangulate or abort them. And whatever else one might conclude, one cannot argue with the fact that India has too few banks. 

The writer  is with Institutional Investor Advisory services, a proxy advisory firm. Views are personal. @AmitTandon_in