New banks: More the merrier but will they be better?

There is evidently a lot of excitement over the prospect of new private banks coming into the fray. The story is not really new as RBI had followed the protocol of drawing up the framework and inviting applications for deciding the right candidates. Now with a change in guard at the RBI and a new Committee in place to shortlist the eligible players a timeline has also been announced by when we will get to know who is in and who is out. A lot of interest has been shown by 26 entities. To top it all the finance minister has spoken of seven licenses being issued, and while the number will be decided presumably by the Committee, the fact that we will have multiple players is exciting enough.

The applicants come from varied backgrounds which will offer diversity. The idea here is to discuss the issues involved and whether the banking landscape will be different. It may be recollected that the RBI has specified fairly rigorous norms in terms of background of the promoter as well as ownership pattern and the capital required. More importantly it has stipulated that the banks will have to show commitment to inclusive banking and have a fixed number of branches in rural areas (25%). Governance principles have also been put in place. Let us see how much sense this makes.

Should there be more banks in the country?

First, in a free society there should be no barriers to entry and hence having more banks is good as long as they are eligible, and the RBI has addressed this issue carefully as they deal with public money. Second, more banks means more competition and customers will have more choice. This was witnessed when the first set of new private banks came in and revolutionized the way in which banking was conducted in the country. This second phase will certainly be useful. Third, we need more banks because there is a high demand for capital going forward. While banks are well capitalized today with most of them having capital adequacy ratios of above 12%, the future demand for capital is challenging.

Sample this. To maintain growth of 8% per annum in GDP on a regular basis we need credit to grow by 20% per annum, as banks still are the main source of finance for borrowers. Based on today’s outstanding credit, and a capital adequacy ratio of 9% (though RBI is asking for 12% for new banks), we would require something like $150 bn in the next 5 years, of which not more than 30-40% can be supported by internal accruals. The public sector banks need to be capitalized, but the government may not have the funds for the same given the fiscal problems that confront us. Getting in more banks with deep pockets will definitely help to keep pace with this requirement. Fourth, the financial sector is definitely more profitable than manufacturing and hence there is reason for corporate houses to diversify into this area, which should be allowed provided the rules are obeyed.

There are however some fundamental questions that we need to answer or be clear about based on the past history of private banks. Last time when 12 licenses were given in two sub-phases, we have seen that it was only the institutional backed banks that have survived with one industrial house being an exception among the new entities. Therefore there is no guarantee that there will not be players who would be keen on selling out at a later stage and exiting the business. Assuming that we are prepared for this possibility, certain other issues remain.

First, will we have more products offered to customers?

The answer is probably not because the bouquet offered today thanks to the advent of the new private banks are comparable to those in western markets and there is really little more to be done on this front except adaptations. Technology was the differentiating factor earlier through ATMs, mobile and Internet banking. All this has already been achieved. In a way it will be easier for the new players who will not have to experiment.

Second, will cost of banking come down?

While customers have had access to more products, they have also had to pay more for banking services. This was not the case prior to 1993. Therefore, with more banks coming in while there would be reduction in costs to begin with, finally things may not change significantly. Besides, RBI has been regulating the charges on different services which can be a mitigating factor.

Third, will the spread of banking increase?

The present structure is quite revealing. New private banks today have an average of 1388 branches (over 20 years), while nationalized banks have an average of 2724 and SBI and its associates 3550. Therefore, over a period of time, the spread could be on similar lines, with 25% being located in unbanked rural areas! Therefore, the reach of banks will definitely improve especially in rural areas.

Fourth, will the depth of banking increase in terms of business - deposits and credit?

The answer is a shoulder shrug. If one looks at the concentration of banking over the years we get an interesting picture. In 1998 RBI data shows that the top 100 centres accounted for 59% of deposits and 69% of credit. The same increased to 69% and 77% respectively in 2007. For the subsequent period, RBI data looks at the top 200 centres where the picture is similar. In 2008, top 200 centres accounted for 75% of deposits and 81% of credit, while in 2013, the numbers were almost unchanged. The conclusion that can be drawn is that banking will continue to be concentrated and forcing banks to open branches in rural unbanked areas, may not really bring the desired results and could be a cost that they have to bear. Banks have to perforce concentrate on the more lucrative centres to protect their profit lines.

Fifth, will employment increase? To the extent that new entities are coming up, there will be fresh employment opportunities. If existing NBFCs convert to banks, then the incremental employment would be limited. However, new entities being created would necessarily mean more jobs for bankers, which is good for the system.

Last, will bank balance sheets look better?

Here again there is a shoulder shrug. To get business banks will have to work on lower spreads and unless costs can be controlled, which will be a challenge given the 25% norm, there will be pressure on profit margins. The existing banks would be better off as such costs have already been buffered in their systems. But new ones will not have to experiment and hence there would be savings there.

Therefore, having more banks is definitely a good idea as it will usher in more competition which will probably mean better services. In terms of spread of inclusive banking, one may not be too sure as the question is that if there were opportunities, the existing banks would have already been there. But quite surely the RBI will ensure that branches come up in these regions. Employment will increase and there will be better choice for the customers and at the macro level, we will get more capital, which is the need. In short, while we will experience new banks, it will largely be business as usual.