New bank licences: Waiting for Godot

Finance minister P. Chidambaram has kept his word. He has pushed through an amendment to banking laws in Parliament to strengthen regulatory powers of the Reserve Bank of India (RBI) even if that meant dropping a clause in the Bill that would have allowed commercial banks entry into commodity futures trading.

Under the current norms, RBI has the power to remove a director or any officers of a banking company but, according to the regulator, this is not adequate if the entire board of directors is working against the interests of depositors and the bank. Now, RBI is empowered to supersede any bank board that acts in rogue fashion. Then it can appoint an administrator for managing the bank for up to one year. Besides, RBI can also seek information from and inspect, if required, associated companies of the promoter of a bank.

The newly acquired powers should encourage the central bank to speed up the process of giving licences to a new set of private banks in a nation where 40% of the adult population does not have access to banking services. Former finance minister Pranab Mukherjee surprised the RBI when he announced in his February 2010 budget that a new set of private players would be allowed to set up banks. The objective was to expand banking services, or the so-called financial inclusion. Till that time, the central bank was harping on consolidation in the banking sector, and not expansion, as none of the Indian banks has global scale. A reluctant RBI first released a discussion paper in August 2010 and in August 2011, it issued the draft guidelines on new bank licensing, seeking public comments.

The reluctance stems from the fact that industrial houses, if allowed to enter the business of banking, can play mischief by using public money for their own benefit and denying money to the competition. Clearly, RBI lacks conviction in its ability to supervise smart companies. One cannot entirely blame the regulator as industrial houses handling of the banking business in the past had not been great. Which is why the government had to nationalize private bank 14 banks in 1969 and six in 1980.

Well after two decades of bank nationalization, RBI opened the doors for a set of new banks in January 1993 when it issued guidelines on the entry of new private banks. It received 113 applications, many from large industrial houses, but except for one none was given and that too came in the guise of a group of non-resident Indian investors belonging to a particular community. Noted economist-bureaucrat Sharad Marathe, the first chairman of the erstwhile Industrial Bank of India, reviewed the applications. Nine new banks were set up and one cooperative bank was allowed to convert itself into a commercial bank.

Eight years later, in January 2001, RBI issued guidelines for a second set of new banks. This time, the regulator made it clear that no industrial house would be allowed to set up banks and the number of licences would be restricted to two or three, to be given in the next three years. It also said if the number of acceptable proposals of the highest standards were more than three, this limit could be relaxed but the period for issuing new licences would be stretched to four or five years. Ultimately, two licences were issued, including conversion of a non-banking finance company into a bank, based on the advice of a three-member external committee consisting of I.G. Patel, former RBI governor; C.G. Somiah, former Comptroller and Auditor General of India; and Dipankar Basu, former chairman of State Bank of India.

This time around, it is fairly clear that industrial houses will be allowed to set up banks as expansion of banking services can be possible only if the promoters have deep enough pockets to spend on technology and talent. Two critical things to watch out for are how fast RBI is willing to open the doors for the new set of banks and how many of the aspirants will get the nod. There is no reason to believe that the queue will be shorter this time than in 1993 as the past two decades have seen the emergence of quite a few new corporate houses that harbour ambition to float banks. Besides, there are many aspirants in the financial services sector that weren’t there in the early 1990s as the sector virtually didn’t exist before India embraced economic liberalization.

It will not be easy for the regulator to choose the so-called fit and proper candidates eligible for licences and one can expect the formation of an external committee for vetting the applications after the regulator screens them. Unlike telecom spectrum or natural assets like oil and coal, banking licences cannot be auctioned to the higher bidder. The focus here is on the profile of the aspirants and their background an acid test for RBI’s own credibility. The regulator should not be worried as barring a couple of instances Palai Central Bank in Kerala in 1961 and Madhavpura Mercantile Cooperative Bank in Ahmedabad in 2000 India does not have a history of major bank failures.

Armed with the amended banking law, if RBI chooses to release the final guidelines in January, giving a three-month window to the aspirants to apply for licences, and takes another three months to identify the right candidates, the first licences should be handed out before governor D. Subbarao’s term ends in September. RBI should have an open mind to allow as many entities to set up banks as it finds fit and proper. It’s almost three years since the budget announcement how long should we wait?

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