The widely-anticipated draft guidelines on new banking licences for the private sector were finally released by the Reserve Bank of India (RBI) early this week. Overall, the guidelines got a warm response, although doubts remain on the interpretation of a few terms.
Key highlights of the draft include a minimum capital requirement of Rs 500 crore, a 49 percent cap on foreign shareholding and the barring of corporate groups with 10 percent or more of their income or assets from/in the broking and real estate businesses from applying for a bank licence. In addition, only private sector groups are eligible to apply for a bank licence, which leaves companies like Power Finance Corporation and Rural Electrification Corporation out of the loop.
While most of the guidelines are straightforward, there is quite a bit of confusion on the term "diversified ownership". Most experts think that depending on the correct interpretation, different sets of companies could be excluded or included.
According to an IDFC report: “Though corporates are eligible to apply for banking licences under these norms, there is ambiguity on how RBI would define diversified ownership. As a result, clarity is yet to emerge on the eligibility of Reliance Capital — a promoter holding of 54 percent — Baja Finserv (58 percent) and Mahindra & Mahindra (25 percent).”
The guidelines also state that a new bank has to be set up through a non-operative holding company, which will not only hold the bank but also all other financial services companies. If the promoter already has a non-banking finance company (NBFC), that NBFC can either be converted into a bank or pass on all banking-related activities to the new bank.
In a report, Standard Chartered noted that this condition is harsh for Mahindra and Mahindra (M&M) and Shriram groups, as they had earlier said they would prefer to retain their NBFCs. But the rider might not have too much of an impact on large corporate groups such as Tata or Reliance, because they don't have a meaningful financial services business. The criteria might also not impact the plans of Reliance Capital or Aditya Birla Nuovo because these organisations are engaged in activities that banks do not undertake.
For NBFCs themselves, there might be some problems because if they convert to banks, their returns on assets (RoA) and equities (RoE) will slide, as the returns of banks are much lower than those of NBFCs. For instance, M&M Finance earns 4.5 percent on its assets and about 24 percent on equity. The best private bank, in contrast, earns just 1.6 percent on its assets and less than 20 percent on equity.
At the time of applying for a licence, all new banks must also explain how they can help in "financial inclusion"; every new bank must also open 25 percent of their branches in unbanked rural areas. This criterion is new and did not exist the last time the central bank issued bank licences.
What is the implication? For one thing, the cost of setting up a bank will go up as the time taken for a rural branch to turn profitable is much longer than for urban ones. Moreover, the bank has to maintain a capital adequacy ratio of 12 percent for the first three years, which is also considered a bit high, given that the investment to set up a bank is quite large. The central bank also wants new banks to become public — list on stock exchanges — within two years; given the initial investments and adequacy ratios, most new banks might not be in a position to show much in terms of earnings to prospective investors during that time, according to some analysts.
So, who are the most likely recipients of a banking licence?
The most common candidates among brokerages are Shriram Transport, L&T Finance, Bajaj FinServ, M&M Financial Services and IDFC. Standard Chartered, meanwhile, believes the guidelines favour Reliance Industries, Reliance Capital, the Tata Group and the Aditya Birla Group, while being less positive for existing NBFCs such as M&M Financial Services and Shriram Transport, since these companies will have to merge their asset-financing businesses with the bank.
The "must not have 10 percent or more income/assets from broking/real estate activities" condition also means that companies like Indiabulls are out of contention. However, Religare remains in the race as an official from the group told CNBC that the promoter group had a stake in Fortis as well and therefore, had less than than 10 percent of their overall income/assets in broking. However, this clause has scope for multiple interpretations, so we'll just have to wait and watch.
Religare Enterprises has already set up an advisory committee to chart its strategy and said that it is open to partnerships with global lenders. The Vijay Mahajan-promoted Basix Group, which own microfinance firm Bhartiya Samruddhi Finance, has also indicated that is interested in applying for a bank licence. SKS Microfinance has also said it is open to floating a new bank.
The RBI has indicated that all applications will be posted on its website and that all the applicants will be considered by a core group, although the final decision will lie with the regulator.
The central bank has emphasised that merely meeting all the guidelines will not be enough to win a licence and qualitative factors such as corporate governance and promoter reputation, will also be taken into account before making a final decision. That could hamper the chances of players like the ADAG Group and Srei Infrastructure, according to some analysts.
One thing's for sure, several companies are interested in setting up a bank. The ones that finally make the cut will inevitably change the banking landscape forever.