Challenges that awardees of new banking licences face
The new banks cannot survive by being mirror images of existing banks.
They have to harness their knowledge based on products they are familiar
with.
The banking sector has been abuzz ever since the Reserve Bank of India (RBI) announced the guidelines for new banks. Boardroom discussions have centred on whether there is indeed a need for new banks, whether these would be able to compete with the pioneers in the industry, and how the coming of new banks would impact existing banks' balance sheets. Industry leaders are trying to work out the answers.
Currently, there are 26 public sector banks, 20 private sector banks and 43 foreign banks. These are complemented by 61 regional rural banks (RRBs) and more than 90,000 credit cooperatives.
Despite the impressive strides made by the financial sector in business expansion, profitability, return on assets (RoA) and competitiveness, vast segments of the population are still untouched by it. There is still a need to bridge the gap between the privileged and the underprivileged sections.
Until now, financial inclusion had been the responsibility of public sector banks alone. But by using inclusive growth as one of the criteria for new licences (new banks have to open 25 per cent of their branches in rural areas), the RBI will have made the new private sector banks responsible as well. Currently, public sector banks have more branches than any other bank group in the rural and semi-urban areas.
So, what attracted the 26 applicants who have sought new banks licences? The fact that India is one of the top 10 economies of the world, with relatively low domestic credit to gross domestic product (GDP) ratio, and thus provides a great opportunity for the banking sector to grow. The sector is expected to become the fifth-largest by 2020 and the third-largest by 2025. Also, banking credit is likely to grow at a 17 per cent compound annual growth rate (CAGR) in the medium term (from 2011/12 to 2016/17), leading to increased credit penetration.
The new banks cannot survive by being mirror images of existing banks. They have to harness their knowledge based on products they are familiar with. The applicants are a diverse bunch including non-banking financial companies (NBFCs) engaged in asset or commodity-based financing, industrial houses (engineering, infrastructure, telecom, media, technology companies), services companies (transporters, distributors, exporters, importers), all of them scattered across geographies. The successful transition from an NBFC to a bank, for instance, will depend on strong management, as it would be moving into new businesses with uncharted risk areas.
Good customer service is essential in the industry. The new banks will have to deliver on this score. What would, moreover, set them apart would be their ability to find the gaps between the saturated markets which existing banks may have ignored - especially the micro, small & medium enterprises (MSME) segment, women-led businesses, traders and middlemen in agriculture, wholesale banking, totally under-banked markets with unorganised professions or corporate banking - and use different operating models to reach out to these customers.
Last but not the least, the success of the new banks will depend on their ability to manoeuvre their way in rural areas with a cost-effective operating model, and develop strong ties with microfinance institutions and banking correspondents, which have proper governance control and local market knowledge.
As far as industrial houses go, the key reason for the regulator forbidding them from applying for licences earlier in 1993 and 2004 was corporate governance. This time, however, there are reasons to allow corporate houses into the banking sector. First, they have deep pockets. Many have other financial services businesses and are aware of their customers. The regulator has also provided a number of safeguards in the guidelines. The proposed non-operative financial holding company (NOFHC) structure is expected to ring-fence regulated financial service entities of the group (including the bank) from other group businesses.
The RBI will be comfortable about handing out licences to industrial houses if the latter have strong governance and strong risk management processes in place. New banks have to adhere to strong risk management processes to ensure there are no deviations from regulatory norms and they are not responsible for triggering systemic risk in the banking system.
The regional spread of banking services has remained skewed over decades. There is a mismatch between aggregation of deposits and deployment of credit, which needs to be addressed, with south India at one end (with the maximum credit) and the north-east region at the other (with the least). It will be interesting to watch for the regulator's strategy on regional and sectoral disparities and how new banks respond to that.
The regulator is also mulling over issuing differentiated licences. This could help new banks focus on niche lending and get regulatory treatment different than other banks. Some countries have a differentiated bank licensing regime where licences are issued specifically outlining the activities the licenced entity can undertake. Singapore, for instance, has five different kinds of licences - full bank, qualifying full bank (QFB), wholesale bank (WB), offshore bank, and representative bank - while Hong Kong has a three-tier structure based on licence, restricted licence, and deposit taking companies. Further, the regulator is also considering making bank licences available on tap to those who fulfil the necessary conditions, rather than grant licences only for a limited time.
It will be interesting to see how the banking landscape changes with the newcomers. Issuing new bank licences is just one aspect of larger financial sector reforms. Both the government and the new RBI Governor Raghuram Rajan are committed to financial services reforms. There could be significant policy level directions in the areas of consolidation and presence of foreign banks in India. There could even be complete reorientation of the banking structure.
Currently, there are 26 public sector banks, 20 private sector banks and 43 foreign banks. These are complemented by 61 regional rural banks (RRBs) and more than 90,000 credit cooperatives.
Despite the impressive strides made by the financial sector in business expansion, profitability, return on assets (RoA) and competitiveness, vast segments of the population are still untouched by it. There is still a need to bridge the gap between the privileged and the underprivileged sections.
Until now, financial inclusion had been the responsibility of public sector banks alone. But by using inclusive growth as one of the criteria for new licences (new banks have to open 25 per cent of their branches in rural areas), the RBI will have made the new private sector banks responsible as well. Currently, public sector banks have more branches than any other bank group in the rural and semi-urban areas.
So, what attracted the 26 applicants who have sought new banks licences? The fact that India is one of the top 10 economies of the world, with relatively low domestic credit to gross domestic product (GDP) ratio, and thus provides a great opportunity for the banking sector to grow. The sector is expected to become the fifth-largest by 2020 and the third-largest by 2025. Also, banking credit is likely to grow at a 17 per cent compound annual growth rate (CAGR) in the medium term (from 2011/12 to 2016/17), leading to increased credit penetration.
The new banks cannot survive by being mirror images of existing banks. They have to harness their knowledge based on products they are familiar with. The applicants are a diverse bunch including non-banking financial companies (NBFCs) engaged in asset or commodity-based financing, industrial houses (engineering, infrastructure, telecom, media, technology companies), services companies (transporters, distributors, exporters, importers), all of them scattered across geographies. The successful transition from an NBFC to a bank, for instance, will depend on strong management, as it would be moving into new businesses with uncharted risk areas.
Good customer service is essential in the industry. The new banks will have to deliver on this score. What would, moreover, set them apart would be their ability to find the gaps between the saturated markets which existing banks may have ignored - especially the micro, small & medium enterprises (MSME) segment, women-led businesses, traders and middlemen in agriculture, wholesale banking, totally under-banked markets with unorganised professions or corporate banking - and use different operating models to reach out to these customers.
Last but not the least, the success of the new banks will depend on their ability to manoeuvre their way in rural areas with a cost-effective operating model, and develop strong ties with microfinance institutions and banking correspondents, which have proper governance control and local market knowledge.
As far as industrial houses go, the key reason for the regulator forbidding them from applying for licences earlier in 1993 and 2004 was corporate governance. This time, however, there are reasons to allow corporate houses into the banking sector. First, they have deep pockets. Many have other financial services businesses and are aware of their customers. The regulator has also provided a number of safeguards in the guidelines. The proposed non-operative financial holding company (NOFHC) structure is expected to ring-fence regulated financial service entities of the group (including the bank) from other group businesses.
The RBI will be comfortable about handing out licences to industrial houses if the latter have strong governance and strong risk management processes in place. New banks have to adhere to strong risk management processes to ensure there are no deviations from regulatory norms and they are not responsible for triggering systemic risk in the banking system.
The regional spread of banking services has remained skewed over decades. There is a mismatch between aggregation of deposits and deployment of credit, which needs to be addressed, with south India at one end (with the maximum credit) and the north-east region at the other (with the least). It will be interesting to watch for the regulator's strategy on regional and sectoral disparities and how new banks respond to that.
The regulator is also mulling over issuing differentiated licences. This could help new banks focus on niche lending and get regulatory treatment different than other banks. Some countries have a differentiated bank licensing regime where licences are issued specifically outlining the activities the licenced entity can undertake. Singapore, for instance, has five different kinds of licences - full bank, qualifying full bank (QFB), wholesale bank (WB), offshore bank, and representative bank - while Hong Kong has a three-tier structure based on licence, restricted licence, and deposit taking companies. Further, the regulator is also considering making bank licences available on tap to those who fulfil the necessary conditions, rather than grant licences only for a limited time.
It will be interesting to see how the banking landscape changes with the newcomers. Issuing new bank licences is just one aspect of larger financial sector reforms. Both the government and the new RBI Governor Raghuram Rajan are committed to financial services reforms. There could be significant policy level directions in the areas of consolidation and presence of foreign banks in India. There could even be complete reorientation of the banking structure.
