The New Banking Brigade

The banking sector in India has always remained a very vibrant one, and why not, the kind of growth India has been witnessing, it had to be supported by a strong banking system. If the performance of the Indian banking sector is anything to go by, it seems that it has been strong enough having weathered all storms well. Prudent practices and conventional framework adopted by the regulator (RBI) has not only insulated Indian banks from the global financial crisis but have also helped the sector grow leaps and bounds. 

Though RBI has been very conservative in its approach, it has continuously kept pace with time for the advancement of the sector. Even amid all the volatility on the domestic as well as global front the Indian banking sector has done reasonably well. With its agenda of lot many reforms, the regulator has also been very keen on financial inclusion to ensure reach of banking services and financial products to rural areas, to cater to a majority of the population at lower end of the economic pyramid.

If the choice is between financial inclusion and creating mega global banks, RBI will see strong case for new banks with mandate to reach out to the unbanked areas and people. For the same it has not only tried to increase the penetration of the existing banks, but has also provided opportunities to the new players by issuing banking licenses. While the first round happened in 1993 where around 10 licenses were provided the second happened in 2001 where only 2 were allowed into the banking fold.

The third is now in the wings. Around 26 new entities are seeking license to enter the banking business now. The decision to allow more private sector players is in line with the RBI’s continued efforts to push reforms. Just to quantify the need of financial inclusion in India we would like point out towards one data. The account penetration in high-income and developing economies differs substantially. While it is nearly universal in high-income economies, with 89 per cent of adults reporting they had accounts in a formal financial institution, in the case of developing economies, it is almost half at 41 per cent. According to a recent World Bank study, globally only 50 per cent of adults reported having accounts at formal financial institutions. Currently, only 35 per cent of the population in India has a formal bank account as compared to an average of 41 per cent in other developing economies. This clearly indicates the gap that has to be filled. 

After a long gap of 12 odd years, the RBI has again invited applicants to seek banking licenses. But before we take a look at who are going to be promising candidates, let’s have a look on how was the performance of banks that were provided licenses on the past two occasions.

The Background

This is the first time in more than a decade that fresh banking licenses will be issued. This is also the first time that corporate and industrial houses are being considered as eligible entities that can enter the sector. Following the nationalisation of 14 large banks in 1969 and another six in 1980, the RBI has so far provided licences to just 12 new banks in two phases, including the conversion of a co-operative bank into a commercial bank in the first phase. 10 banks were licensed on the basis of guidelines issued in January 1993. These included:

• Global Trust Bank
• ICICI Bank
• HDFC Bank
• Axis Bank
• Bank Of Punjab
• IndusInd Bank
• Centurion Bank
• IDBI Bank
• Times Bank
• DCB Bank (then Development Credit Bank)

Afterwards considering the performance of these 10 banks, the guidelines were revised in January 2001 based on the experience gained from the functioning of these banks and fresh applications were invited. After detailed deliberation, two more licences were issued in 2003-04 to Kotak Mahindra Bank and YES Bank.

Past Performance – Mixed Signals

If we look back at the performance of the banks that were awarded Banking licenses earlier, it has been a mixed one. While one lot has done extremely well, the others have even struggled to sustain their operations, leading to a lot of consolidation in the sector. To name a few, Centurion Bank and Punjab Bank got merged to become Centurion Bank of Punjab, which was later taken over by HDFC Bank. Even Times Bank got merged with HDFC Bank eventually. Another example is that of the scam-hit Global Trust Bank which was then taken over by the Oriental Bank of Commerce in a distress sale.

While these are some examples of failures, there are good performers as well. HDFC Bank, ICICI Bank, IndusInd Bank, Axis Bank (then UTI Bank), Kotak Mahindra Bank and YES Bank have created good value for their stakeholders. The following table shows returns provided by banks since the second round of licenses was over.

The past performance clearly indicates that the quality of management has played a pivotal role in terms of the business excellence that these banks have demonstrated. All this has seen the RBI be more cautious this time around and the policy framework has been worked out after detailed discussions with different groups. One noticeable factor this time is the consideration of Non-Banking Financial Companies as being eligible for application of a license, if they meet the RBI’s criteria. After detailed discussions with all the vital players that were likely to get involved, in February 2013 the RBI issued the final guidelines.
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Requirements And Eligibility

The final guidelines laid down criteria with respect to promoter eligibility, corporate structure, foreign shareholding, corporate governance, prudential and exposure norms; both on a standalone and a consolidated basis. The applicants will have to prepare a detailed project report and a business plan giving details, amongst other things, of how they propose to achieve financial inclusion. 

The promoter group will be permitted to set up a bank through a wholly- owned non-operative financial holding company (NOFHC). The NOFHC envisages holding of the bank and other regulated financial services entities of the promoters under the NOFHC and prudential exposure norms for the entities. However, the RBI has set forth the following restrictions on the capital structure of NOFHCs:

• Voting shares of individuals should not exceed 10 per cent
• Promoter companies with 51 per cent or more public shareholding should own at least 51 per cent of the voting shares
• Minimum capital requirement is Rs 500 crore 
• NOFHC should own a minimum 40 per cent of the paid-up voting equity capital, which will be locked in for five years 
• Shareholding should be brought down to 40 per cent/20 per cent/15 per cent within 5/10/12 years 
• Foreign shareholding will be limited to 49 per cent for the first five years 
• The group also has to transfer all its financial businesses to the NOFHC

Applicants must have a “successful” track record for 10 years and a high net worth. Statutory reserve requirements must be met immediately with four per cent of deposits placed with the RBI and a holding of 23 per cent in government bonds from day one. Any new bank will have to commit to open one in four branches in rural areas (population up to 9999 as per the latest census) to avoid over concentration of their branches in metropolitan areas and cities which are already having adequate banking presence. Also, within three years, they must 

meet the target of lending 40 per cent to the priority-sector. Apart from that the bank will have to get its shares listed on the stock exchanges within three years of the commencement of business by the bank. 

While adherence to the capital norms is not being doubted, questions are being raised about the rural penetration norms. However, on the rural banking front we feel, the opening of rural branches is not going to be as painful as it once used to be. Rural India is fast moving towards urbanisation and growth there may be faster than in metros. But priority sector lending is a drag on profits and a political dole. A large proportion of priority sector loans are write-offs from day one.
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Other Developments

One major development that is in contrast with its draft guidelines is that, the RBI has removed a ban on brokerages and realtors from applying for banking licences. But winning a licence may be tougher for these companies as the central bank has stipulated that bank promoters’ business culture should not be misaligned with the banking model. In its clarification in June 2013, the RBI had said the entities getting licences to open new banks would be given 18 months to open branches, and promoters would have to transfer their holdings to the NOFHC in a stipulated period.

Notwithstanding the current FDI policy, where foreign shareholding in private sector banks is allowed up to 74 per cent of the paid-up voting equity capital, the aggregate non-resident shareholding from FDI, NRIs and FIIs in the new private sector banks shall not exceed 49 per cent of the paid-up voting equity capital for the first five years from the date of licensing of the bank.

Viability

Aspiring Canditates
Aditya Birla Nuvo, Mumbai.
Bajaj Finserv, Pune.
Bandhan Financial Services Pvt., Kolkata.
Department of Posts, New Delhi.
Edelweiss Financial Services, Mumbai.
IDFC, Mumbai
IFCI, New Delhi.
Indiabulls Housing Finance, New Delhi.
India Infoline, Mumbai.
INMACS Management Services, Gurgaon.
Janalakshmi Financial Services Pvt., Bangalore.
J M Financial, Mumbai.
LIC Housing Finance, Mumbai.
L & T Finance Holdings, Mumbai.
Magma Fincorp, Kolkata.
Muthoot Finance, Kochi.
Reliance Capital, Mumbai.
Religare Enterprises, New Delhi.
Shriram Capital, Chennai.
Smart Global Ventures Pvt., Noida.
SREI Infrastructure Finance, Kolkata.
Suryamani Financing Company, Kolkata.
Tata Sons, Mumbai.
Tourism Finance Corporation of India, New Delhi.
UAE Exchange & Financial Services, Kochi.
Value Industries, Aurangabad.

There are large number brokerages, which are high-margin, high-risk lenders. If they receive access to low interest retail deposits, they could expand in scale. Some applicants have high exposures to vehicle finance. Another stream is gold-backed financing, which is a key for Muthoot Finance, for example. Recent evidence shows how very risky these revenue streams can be. Margin calls can wipe out brokerages, commercial vehicle loans drop in volume and go sour in cyclical downturns, and gold-backed financing incurs big risks when prices drop. Existing banks also have fingers in these pies. But their securities trading operations are hived off. The new entities must also create walls, quite apart from developing commercial banking skills.

Where They Stand

Two of the government applicants are surprising. India Post has an easy task in terms of fulfilling branch network requirements and also a base of low-cost retail deposits. It is wholly government-owned. Its net worth is unknown and so is the current portfolio. Tourism Finance Corporation of India is also applying from the remaining field. Many fear that it may not meet the capital base criteria and appears to have little relevant experience. But the TFCI management is quite confident of gathering capital with help from its parent companies and is looking at SME business for growth. A third PSU player, IFCI, has a poor track record and a large portfolio of sticky assets. But being a PSU, it also has many advantages like lower cost capital.

Big industrial groups like Aditya Birla, Tata Sons, Videocon, L&T and Reliance Capital will all meet the net worth and capital criteria with ease. But again, banking is a totally different genre as compared to insurance business and other financial services. 

We are of the opinion that, the RBI will have to think deeply before allotting licences to one or two corporate houses and denying it to others. Like the large private players IDFC and LIC Housing Finance are two other “serious” applicants. All have some experience at specific financial segments. 

The others are relatively unknown players. Suryamani Financing Company (SFCL) is part of the Kolkata-based Pawan Kumar Ruia Group, promoter of the beleaguered tyre maker Dunlop India. INMACS group was incorporated in April 1984 and is promoted by finance professionals and spearheaded by chartered accountant Vinod Jain. It began by offering a range of services like management consultancy and corporate finance. UAE Exchange is one of the leading global remittance and foreign exchange brands, with direct operations spanning 31 countries. The UAE Exchange has completed 32 years of business operations.
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The Expected Contenders

Given the demand for the license, it would not be easy to select five or six names from the list of 26 aspirants. It may be a combination of two PSUs and four Private enterprises who will have the brand, reach (geography and clients) and financial strength to compete with existing Banks to propel efficiency of banking and financial services to higher level in the years to come.

The logical way for any process to operate is not to go by names, but to go by category. So, looking at the 26 entities that have applied, there are five basic buckets of categories. The first one is corporate; there are four corporate entities in the fray, then there are NBFCs; around 15 of them have applied. These are followed by broking firms and government entities and others. So, the government has to take a view within these five buckets.Among corporate entities there are two straight front-end corporates, but there are two others which are backed by corporates. Similarly, among NBFCs, there are pure play NBFCs as well as corporate-backed as well as government-backed NBFCs. So, there are three categories within NBFCs. Then, you have broking firms of a certain kind and government departments/ undertakings, like the department of posts. So, ideally one would want a mix of these candidates.

Why Is The Licence So Valuable?

For most aspirants, building a client base and business around them is not an issue on the other hand a major advantage will be that of being able to build a low-cost liability franchise through products that would involve use of savings and current account. One issue for them will be the transfer of intrinsic enterprise value from existing business to a new business at some discount to cover costs relating to statutory requirements and priority sector lending. However the benefit will accrue from access to relatively cheap sources of funds so as to retain the net financial intermediation margin. So, one can expect good value creation from these entities from the banking licences. 

Another important factor is, it is been done with a view of financial inclusion in India. Hence there is a compulsion of opening branches in rural areas. While many on the street are expecting the rural compulsion as a burden, we feel it is an opportunity for the new players. Industrial development is not anymore happening in Tier I cities rather it is happening in Tier III and IV cities. With large number of SMEs in the rural area, we feel it will be a major growth driver for the new license holders.

Naturally as the opportunity is being provided after one decade and is being provided to NBFCs the licenses are valuable for the entities that have applied for them. Will it result in financial inclusion? The RBI has been focusing on the same since long, but we are yet to achieve financial inclusion. This is another step towards the same, and we feel that it would surely lead us towards the goal. However, some things need time to grow and similar will be the scenario with financial inclusion. It will happen is for sure, but when, only time will tell.