Banking licence: Tata Sons' pullout points to a missing link in policy

When the RBI opened the doors, and invited applications for issuance of fresh bank licenses, the response was one of ecstasy. Coming as it were after almost two decades, there were a number of players who put forth their applications, which though lower than the 100 odd applicants in the nineties, were still impressive. The big corporate houses have seen an opportunity, and the lessons learnt from the earlier experiences have been kept at the back of the mind before attempting to jump into the fray. There was some skepticism expressed by critics, but the majority view was that if business houses that run successful businesses even under the most trying conditions saw light at the end of the tunnel, the critics were unnecessarily spoiling the party.

The news that Tatas have withdrawn their application is significant as it brings on the table the preconditions that have to be met as well as the business model to be pursued in future. As it has come a couple of months after the application was put in, one can assume that a lot of thought has gone into this decision after deep introspection. The preconditions on ownership pattern and relations with other group companies have not quite been discussed and hence the Tata response should set other aspirants thinking.

The RBI logo. Reuters

The RBI logo. Reuters

The official reason given by the Tatas is that given that it is global and their bank would be incorporated under the non-operative financial holding company (NOFHC), it would get in the way of their own operations in other geographies. This is where the first potential, to use the RBI Governor's pet word, fault line lies. A corporate getting into this business will have to resolve the conflict of interest between the bank and its other business interests.

When ICICI Limited or IDBI Limited started such banks in the nineties, this was not an issue as there were no group companies borrowing from the parent. A tractor company or an auto company provides credit through its financial outfit to incentivize sales. Now, if there are restrictions on such activity, as it would involve interconnected lending, then there would be potential compliance issues.

Also most of these large corporate now could have between 50-100 associated companies each having some linkage with banks. Add to this the foreign dimension and there would be less clarity on what regulatory responses there could be from other countries in which they operate. Quite clearly, other corporate houses need to review these possible concerns, as what holds for the Tatas holds for them too. On account of such action being open to interpretation, it is better to wait and watch before coming in later. These licenses would anyway be available on tap.

This will be important because even though the RBI has argued in favour of having such licenses issued on tap and not fixed to such time limits, there are considerations on both sides. A player entering now will have the advantage of the first mover in the sense that if there are opportunities to be had with new entries, then this is the right time. Coming in later may just dilute the potential. On the other hand, waiting will save the pain from experimentation which will be tested both in terms of how conflict of interest is handled as well as the business model being used.

Now the business model prima facie is not very attractive and the obvious attraction is access to cheap current and savings deposits (CASA) which today account for roughly 35 percent of total deposits. Keep this aside, and the new banks have to comply with CRR, SLR and priority sector lending norms from day 1 along with opening 25 percent banks in unbanked areas. The RBI is evidently trying to push these banks to doing something which others are not finding very attractive. In fact, these terms have become 'bad words' internally in the system which looks with some modicum of scorn on CRR which earns no interest, SLR which earns very low returns and priority sector lending, which though good to talk about yields higher NPAs. And while new private banks are trying to charge customers for every service and penalize them for not maintaining a minimum balance, these new banks have to go to these non-profit centres and maintain establishments while complying with the RBI norms.

The RBI has been very transparent about the terms and conditions and hence is beyond reproach. If one finds the terms agreeable, then one can come in and play. Otherwise, they can stay away. The Mahindras did not think this model would work and hence stayed away, while the Tatas exit is a call to corporates to revisit their models. Such conditions would probably allow for break-even only after 5 years, and the RBI norms already state that the promoter will have to divest after 10 years. Therefore, the promoter has to take on these risks which will be the highest in the formative years, and would probably not get the full benefits in the commercial sense after 10 years though society would have gained.

The NBFCs with no interconnected relations with companies will be probably in a better position as they do probably have a network in rural areas also which could become branches. The gains from CASA deposits would be substantial as presently they have to either issue bonds or take fixed deposits that come with higher costs as they compete directly with banks and carry the perception of being riskier.

The one catch which has still not really been clarified is the concept of differentiated licenses. If this means being forced to focus on specific sectors, then the idea of getting into banking may just get a little less attractive. Therefore, while it is still expected that there could be six-eight new banks coming in when the decision is taken, the existing 24 contestants will probably review their own models and look out for any conditions that could come in the way. The ultimate justification for such a review could just be that if a big name like Tata's has seen something that we have missed, then, what is that something?

The author is Chief Economist, CARE Ratings. Views are personal.