New banks: Subbarao says welcome, but don't come in

When you are dragged kicking and screaming to do something you are not happy to do, you will probably ensure failure of the project just to prove a point.

And so it is with the Reserve Bank of India’s (RBI’s) latest guidelines for licensing new banks in the private sector.

It is no secret that while Finance Minister P Chidambaram has been gung-ho about opening up banking to more private entities, including big business groups and foreign banks, RBI Governor Duvvuri Subbarao was never too keen on laying out the welcome mat to all and sundry.

This is why his welcome mat, laid out yesterday, comprises a not-so-red carpet with in-built nails and tripping systems.

The RBI has imposed stiff conditions for eligibility to enter the business. Among other things, new banks have to put up Rs 500 crore as capital on Day One. Then, 25 percent of their branches have to be in “unbanked” rural areas. The RBI’s definition of unbanked areas is villages with a population below 10,000. Assuming this means 2,000 households, it means putting up a branch for fewer than 2,000 live accounts. A quarter of the branches will lose money from Day One.

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But just in case some intrepid promoters are undeterred by these hurdles, the RBI has set up two pole vaults in the end, which will check the enthusiasm of all but a handful of businessmen.

One is the RBI’s “fit and proper criteria”, which demands that promoters must have sound credentials and integrity (sounds good, but isn’t that a given?); then they should have had a “successful” track record of 10 years (what is “successful for the RBI?); and they must have a good rating from the other regulators (if you have crossed Sebi’s or Irda’s path unfavourably, watch out).

But the biggest wet blanket is the condition that the “promoter/promoter groups’ business model and business culture should not be misaligned with the banking model and their business should not potentially put the bank and the banking system at risk on account of group activities such as those which are speculative in nature or subject to high asset price volatility.” (Italics ours)

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The RBI was always been against letting the likes of realtors or brokers or trading companies into the business. Since their business is all about speculation and asset price volatility, this rider will effectively keep them out.

The final hurdle (or, shall we say, biggest nail on the welcome mat?) is the RBI’s clear warning that even if a promoter meets all its criteria, he may still not be allowed near the starting post for the banking race.

This is what the RBI’s guidelines ultimately warn: “Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for RBI to issue licences to all the applicants meeting the eligibility criteria prescribed above. (Italics ours)

There it is: even if you are eligible, the RBI may decide it does not like your face and say no. This is the underlying meaning of phrases like “very selective basis” and subjective criteria like “impeccable track record” or “likely to conform to the best…standards of customer service and efficiency.” If the RBI does not like you, “it may not be possible” to give you a licence.

The counter-point one needs to make is simple: how many of our current public sector banks, not to speak of the new private sector banks, will even qualify on these criteria?

How many public sector banks would clear the hurdle of providing “best international standards of customer service?” How many private sector banks would qualify on the criteria of being “inclusive”? How many Indian promoters with the ability to plonk Rs 500 crore on the RBI’s table would have “impeccable credentials” given that most of them are the products of crony capitalism and regulatory capture? Even the Tatas have the Radia tapes episode to live down, the Birlas got their telecom licences cancelled, and the Ambanis are in trouble with Sebi over alleged insider trading. How many existing banks - from SBI to HDFC Bank - got the rap from Sebi and the RBI for the IPO scam of a few years back?

This is not to say that the RBI has no reason to be cautious about new entrants. In fact, it has better reasons for being so than the finance ministry has for being the opposite. From Global Trust Bank to Bank of Punjab to Centurion Bank to Timesbank, some of the shiny new entrants of the last wave of liberalisation did not manage to survive. Even UTI Bank (now Axis) and IDBI Bank managed to screw up before being rescued by PJ Nayak and Gunit Chadha. Success in private banking is not a given, no matter how well capitalised you are.

On the other hand, bad governance is often the result of the government’s micro-management of public sector banks, including its ham-handed efforts to push banks to lend more injudiciously to cronies - both to political constituencies like farmers or crony businessmen.

Consider now the flaws in the finance ministry’s reasons for licensing new private banks.

First, the assumption that new private banks will help create financial inclusion by heading off to rural areas is debatable. Most rural branches are unprofitable, and if already profitable banks are not rushing in, then new banks are hardly going to be very keen to do so. They will probably go through the motions of going rural and focus on urban areas for business.

Second, India does not have too few banks, as the finance minister seems to think. We have 26 public sector banks (including the State Bank Group), 13 old private sector banks and seven new-generation private sector banks - making 44 banks in call. And this is not counting the urban cooperative banks, the local area banks and regional rural banks. Together, the scheduled banks these banks have over 81,000 branches, and nearly 100,000 ATMs.

As against this, we have over 600,000 villages. That’s an average of one branch for every six or seven villages. Of course, averages hide the reality that thousands of small villages may be miles away from a branch, but even this is changing fast. In 2012, there was a 56 percent jump in the total number of banking outlets (which may be through business correspondents, and not just branches) opened in villages, which soared from 1.16 lakh in 2011 to 1.81 lakh.

Financial inclusion is happening, and it needs more technology and more innovation rather than new bank licences to private players.

Third, if we accept the proposition that we need more branches rather than more banks, it makes more sense to incentivise profitable existing banks to do so. It is easier for a profitable bank to support unprofitable new branches than for a new bank to start on an unprofitable note.

Fourth, the real issue about rural banking is that you need a low-cost business model to supplement the existing high-cost one. By prescribing a high entry cost (Rs 500 crore capital), and adding all the new prudential norms under Basel III, new banks will have higher costs than existing ones. What you need is to get banks to form relationships with existing microfinancing institutions, non-bank finance companies, and private money lenders, who already have low-cost out-reach capabilities. This will lead to better and cheaper ways of financial inclusion. Creating new private banks is hardly the best way to achieve that.

Fifth, the real solution is to invite private investment and participation in public sector banks - either through clean privatisation or by inviting banking professionals to run public sector banks autonomously. This can be achieved by the government retaining a golden share - where it owns 51 percent of voting rights, but the economic ownership is private - and letting professionals or private promoters to run it autonomously.

This is not to say that new banks are not welcome - no sector should ever be closed to any eligible newcomer - but when you have so many underperforming banks in the public sector, what is the point in inviting new people in? They can only damage the viability of existing banks. The government will have to pick up the bill, as usual.

As things stand, the RBI has reluctantly produced a policy to keep most people out, since it does not agree with the finance minister that all kinds of people should be made eligible to run banks.

This means the Tatas, Birlas, Ambanis and Mahindras, and possibly some non-bank financial institutions, may be the only people to get bank licences ultimately. Financial inclusion ought to mean more bank professionals creating new banks rather than allowing only people with inherited money or wealth to enter.

This will be the net result of the RBI being forced to open up the sector to all comers. It has now done so; only the welcome mat looks less than welcome.