RBI not in favour of differential bank licences

The Reserve Bank of India (RBI) has decided against the introduction of differentiated bank licensing system, which would have allowed the banks to operate in niche areas without having to follow priority sector and other regulatory stipulations.

To enable the banking system to operate at optimum levels and in the interest of financial inclusion, it is essential that all banks should offer certain minimum services to all customers, while they are allowed sufficient freedom to function according to their own business models.

Thus, it will be prudent to continue the existing system for the time being, the RBI said in a technical paper on 'Differentiated Bank Licenses' released today.

The central bank said it may be seen that one of the major objectives of the banking sector reforms has been to enhance the efficiency and productivity of the system through competition and to provide services to the maximum number of people.

It said the situation may be reviewed after a certain degree of success in financial inclusion is achieved and the RBI is more satisfied with the quality and robustness of the risk management systems of the entire banking sector. The RBI had mentioned in its 2007-08 annual policy that it would put out a discussion paper on differentiated bank licensing, but instead it issued a technical paper saying India is not yet ready for such a regime.

Weighing the pros and cons of a differentiated bank licensing regime, RBI saw the disadvantages overshadowing advances. It said the penetration of the banking services in India is very low with less than 59 per cent of adult population having access to a bank account and less than 14 per cent of adult population having a loan account with a bank. It said priority sector lending, a requirement which would no longer exist under a differentiated licensing system, is also important for banks.

It further said niche banks depend heavily on ample inter-bank liquidity and any shock leading to liquidity crunch can translate into a run on the bank.

To drive home its point, the RBI cited the recent example of UK's mortgage bank, Northern Rock Bank. Northern Rock has borrowed a total of POUND 16 billion from the Bank of England as a result of a liquidity squeeze in the banking system in the aftermath of the US subprime crisis.

The arguments in favour of adopting was that for a wholesale bank dealing with corporate clients only, it becomes a costly adjunct to maintain a skeletal retail banking presence and it becomes difficult for such a bank to meet priority sector obligations.

Similarly, retail banks may have to create risk management and regulatory compliance structures which are more appropriate to wholesale banks, thus resulting in non-optimal use of resources.

Also, some banks may find it difficult to provide "no frills" facility to economically disadvantaged. For them, the more liberal licensing regime causes a different set of problems.