Banking licence: How banks will manage the shift from their existing business models

When Centurion Bank of Punjab merged into HDFC Bank in February 2008, it took the banking industry by surprise. After all, Centurion Bank had itself acquired two private-sector lenders in the previous three years. So, why did Centurion Bank agreed to be bought by a rival? "Banking is a business of big boys," says Francis D'Costa, who was Centurion Bank's country head for corporate banking until December 2005. The veteran banker certainly knows a thing or two about the big boys of Indian banking. He worked with the biggest boy - State Bank of India -for 20 years and joined Centurion Bank in the mid-1990s in search of better career prospects. Facts support D'Costa's opinion.

The Reserve Bank of India (RBI) has given licences to 12 private-sector banks since 1994 in two phases. Only seven survive now. The top three survivors - HDFC Bank, ICICI Bank and Axis Bank - had strong parentage. HDFC Bank was backed by mortgage lender Housing Development Finance Corp., ICICI Bank was promoted by Industrial Credit and Investment Corporation of India, and Axis Bank by Unit Trust of India. "They had the support of gigantic institutions," says Romesh Sobti, Managing Director and CEO of IndusInd Bank, which got a banking licence in 1994 and was founded by the London-based Hinduja brothers.

Size is one of the many challenges that companies aspiring to get bank licences will face. They will also have to gain public trust and establish a strong brand identity amid stiff competition from established privatesector players as well as state-run lenders. More importantly, the hopefuls will have to adapt to a tightly regulated sector where the business model is vastly different from the other financial services they have been offering until now.

The RBI has received 26 applications from a motley group ranging from some of the country's biggest business houses to little-known players such as Smart Global Ventures. The RBI hasn't said how many licences it plans to grant, but banking sector observers say it may allow four to five new banks. The government and the RBI hope that the new lenders will reach small towns and villages where nearly half of the country's population has no access to banking services.

Why are these companies looking to enter the banking sector? "Banking is a natural progression for us," says Shachindra Nath, Group CEO at Religare Enterprises. Religare, a financial services company which is part of the business group owned by brothers Malvinder and Shivinder Singh, is one of the 26 applicants. Y. Sudhir Kumar Shetty, Chief Operating Officer for global operations at UAE Exchange & Financial Services, agrees. "We already have relationships with millions of customers," he says. Kerala-based UAE Exchange runs a remittances and foreign exchange sales business.

Still, some are skeptical. A banker with a state-run lender says the seven new private-sector banks have a mere 13.3 per cent share of total deposits. "This is hardly an achievement after almost two decades of presence," he says. The counter-argument - State Bank of India was set up in 1955 and traces its origin to the first decade of the 19th century.

The RBI's strict rules for new banks could also pose a problem. It requires them to have a minimum equity capital of Rs 500 crore. They cannot have more than 49 per cent foreign ownership for the first five years. They must open a quarter of their branches in rural areas, and lend to farmers and poor people. They must also invest 23 per cent of their deposits in government securities and set aside another four per cent in cash reserves.

Most banking aspirants operate as non-banking finance companies, which do not have to follow such stiff rules. These restrictions have already deterred some companies.

One of them is Mahindra & Mahindra Financial Services, which decided to not apply for a bank licence at the eleventh hour. This NBFC has historically stayed away from cities to focus on villages and has grown over the past 22 years.

"NBFCs are already doing a good job," says Sanjay Nayar, CEO of private-equity firm KKR India. New banks also cannot merge or acquire assets at will. Any businesses that can also be done by banks will have to be merged with the new bank. Chennai-based Shriram Capital, for instance, is a holding company with assets of Rs 50,000 crore and runs separate units for vehicle loans and consumer loans. It also offers loans against gold and personal loans, besides providing wealth management services and distributing financial products. The business model and profitability of these units is vastly different. Umesh Revankar, Managing Director at Shriram Transport Finance, says it's not certain if the company would be asked to merge its units.

Some NBFCs may well take advantage of their legacies while diversifying into banking. For instance, vehicle loans comprise the largest chunk of IndusInd Bank's retail portfolio as it had merged Hinduja group company Ashok Leyland Finance with it in 2004. IndusInd Chief Operating Officer Paul Abraham says new players will initially play on their strengths and then move into other areas. "Our expertise and domain knowledge was in commercial vehicle finance. That was a legacy, but I'm also very good at it. So why should I leave it," he says.

But it cuts both ways. Many banking aspirants have strengths in a single product line, and may take years to have a balanced product mix. The 25-year-old Tourism Finance Corporation is focused on financing the tourism industry. UAE Exchange has been in the business of remittances for more than three decades. IDFC is an infrastructure finance company set up in 1997.

Bandhan Financial and Janalakshmi Financial are microlenders. LIC Housing offers only home loans while Muthoot offers loans against gold as collateral.

Many companies may also find it difficult to meet the RBI's financial inclusion agenda. Infrastructure lenders IDFC and Srei Infrastructure Finance are not very retail-oriented. Some, such as Bandhan and Shriram Capital, will have an edge here. "Our customer segment is totally different," says Bandhan Chairman and Managing Director Chandra Shekhar Ghosh. "There is no chance of competition with the existing state-run or private banks." Bandhan has 75 per cent of its branches in rural areas.

Ghosh also says microlenders such as Bandhan are different from NBFCs, which have a bigger loan book but fewer clients. "In microfinance, we have a small amount of money but a very large client base," he adds.

Both microlenders and standalone NBFCs may find it challenging to compete with big industrial groups such as the Tatas and Birlas when it comes to retail banking. Monish Shah, Senior Director at consulting and accounting firm Deloitte India, says retail banking is the way forward to expand and drive financial inclusion. But it needs a lot of money to set up branches, hire people and sell a range of products. "It's a capital guzzler," says a private-sector banker.

IndusInd's Sobti says the brand of a strong parent helps in raising retail deposits, especially low-cost savings and current deposits which are the bread and butter of banks. Some others argue that banks backed by corporate houses haven't performed well in the past as banking is not their core activity and tends to get less attention.

Amid all the discussion on the challenges new banks will face in coming years, one important issue has skipped attention. India already has close to 90 commercial banks including state-run, private-sector and foreign lenders. The country also has thousands of rural and cooperative banks. Does it really need more banks? No, says KKR's Nayar. "What India needs are big banks which have bigger balance sheets so that they can lend more," he says. That's a point to ponder.