The Rajya Sabha approved the Banking Laws (Amendment) Bill, 2011, paving the way for a slew of reforms in the Indian banking industry, including the much-awaited issuance of final guidelines for new bank licenses. In its resolve to continue the reforms agenda and get the Bill passed in Parliament, the government dropped two contentious clauses that would have enabled banks to trade in commodity futures and given Competition Commission of India the sole authority for approving banking merger and acquisitions (M&As). The Bill extends Reserve Bank of India’s (RBI) authority as the supreme regulator of the Indian banking system.
RBI’s plea for bringing “enabling legislations” before inviting applications for new banking licenses have been taken into consideration by the government. RBI will be given greater regulatory oversight over local banks, including the ability to overrule boards when banks grapple with financial stress and oversight over acquisition of a substantial stake in banking companies. The onus shifts to RBI now to formulate a clear and transparent set of final guidelines to initiate the process of granting new bank licences. The final policy guidelines may take upto six months to be formulated and the final license awarding may take another six months from that point.
In this period the new banking aspirants ought to frame optimum business models and shore up adequate capital based on the draft guidelines already issued by the RBI. The final guidelines for new bank licences are expected to include a greater focus on financial inclusion, to achieve the government’s target of providing access to financial services for the entire bankable population. The new banking aspirants need to evaluate these implications on their business plans. The new banks need to hit the ground running with innovative products, cost-optimised delivery channels and robust operational processes, to be able to compete effectively with established players. Entry of new private banks will likely trigger a ‘deposit war’ in the market.
The Bill also builds a favorable environment for foreign investments in the banking sector, which is essential to further drive credit growth and meet the upcoming Basel III capital norms. The cap on voting rights for investors will increase from 10 per cent to 26 per cent in private sector banks, and from one per cent to 10 per cent for public sector banks (PSBs), which will help improve corporate governance standards in the industry.
The Bill also brings the much-needed relief for foreign banks: on conversion of Indian operations into local subsidiaries or transfer shareholding to a holding company, without paying stamp duty. Under the current laws, foreign banks are required to pay 20-30 per cent tax as capital gains and stamp duty when transferring branches to a new legal entity. The development will promote growth of operations of foreign banks in India.
The Bill also helps the government’s ambition to create a few Indian banks of global scale through consolidation in the industry. While a significant spurt in banking M&As looks unlikely, calibrated M&A activity in both public and private sector could be seen. However, a significant increase in financial penetration, especially in rural and semi-urban areas, will be imperative for creation of ‘global sized banks’. Deepening of financial inclusion is quintessential in India as more than 50 per cent of eligible population is still unbanked.
The Bill is likely to be a game changer for the Indian banking industry, with renewed strength in driving financial inclusion, increased competition and the likely emergence of global Indian banks. PSBs will also need to use this time to transform their operations to improve their efficiency and customer connect. The timing of the Bill’s passage is apt and is likely to catalyse wholesome growth of the banking industry in its next phase of evolution.
(The author is Partner, Ernst & Young)