Chapter: Competition and Regulatory

issues in Banking Sector of India with a

focus on bank licensing
Introduction
Modern banking, in India, originated during the 18th century and has since, witnessed radical changes.
As of 2015, India accounts for 46 domestic commercial banks (26 Public and 23 Private Sector
Banks) and 43 foreign Banks, collectively known as Scheduled Commercial Banks (SCBs)1. A
network of 92,1142 branches, throughout the country, seeks to provide last mile connectivity of the
banking services. The sector provides employment to approximately 1,096,9843 people in India.

Despite a network this big, banking sector falls short of catering to entire population of India and
almost half of the population, till recently, remaining financially excluded. There have been several
initiatives taken by the Government, RBI and NABARD over the years to fuel financial inclusion
(Annexure I) but the impact have been below expectation. Most recently, the government has shown
rigour to bridge this gap by launching the ambitious Prime Minister Jan Dhan Yojana (PMJDY)
mission. The mission aims to provide at least one bank account to each household, through which
basic financial services like credit, remittance, insurance and pension may be provided. PMJDY, since
its inception in Aug, 20144, has shown tremendous success by opening up 179 million bank accounts5.

Yet only 55 percent of the population is associated to deposit accounts and only 9 percent have
availed credit thorough banks6. Approximately 145 million households remain excluded from banking
services. Current average of one bank branch catering to 14,000 people7 when compared to
governments mission of at least one branch per 1,000 to 1,500 households (approx. 4,000-5000
people), shows that lot remains to be achieved.

The banking sector may have public and private players now, but since inception till 1960s, the
banking industry was dominated by private banks. The established banks then, catered to particular
ethnic and religious communities8 and thus, had limited outreach. In order to swing the focus of banks
to national interest, the Government, in 1960s, decided to nationalise a number of private banks.

Nationalisation
Nationalisation meant that private banks were turned public and the government became the majority
shareholder. Year 1969 saw 14 banks being nationalised and 6 more were nationalised in 19809.
Through nationalisation, the governments overall objective was to achieve a wider spread of bank
credit, prevent its misuse, direct larger volume of credit flow to priority sectors (such as agriculture
and small industries) and to make banks an effective instrument of economic development10.

Box 1: Side-effects of Bank Nationalisation

Nationalisation led to increase in bank outreach, controlling private monopolies, directing funds to
the needy, et al, it also it resulted in some problems creeping in due to lack of efficient planning and
considerations to professionalism and accountability, such as11:
Banks lacked professionalism, owing to politicians, bureaucrats and their relatives on the
board.
In order to promote agriculture and small industries, banks were forced to lend at
unsustainable rates. The rates were even less to cover the cost of loans, which are still

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 effectively as low as 4 percent.12
Middlemen arose in the system, which borrowed from banks at lower rates (4 percent) and
further circulated the money in market (especially to farmers) at multi-fold rates (36
percent).
The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) were kept very high
(15 and 38.5 percent respectively in 1991), which left banks with very little money for
advances.
Primary focus on agriculture and small industries made it difficult for other businesses to
avail loans which adversely impacted business expansion and saw declining exports.

Source: International Journal in Management and Social Science, Vol.03 Issue-02, (February,
2015)

Current scenario highlights the need for strengthening the financial service connectivity in the
country. One possible way may be allowing more full-fledged banks or differential banks focussing
on ensuring last mile connectivity of financial services. In past, Reserve Bank of India (RBI) had
provided licenses to 14 private banks. It has also recently issued in-principle approvals for operations
of differentiated banks such as payment banks and small finance banks. Differentiated banks are
contemplated to meet credit and remittance needs of small businesses, unorganized sector, low
income households, farmers and migrant work force13.

One of the reasons of low penetration of banking services in India may be attributed to low
competition in the sector. A number of studies have indicated that competition drives expansion and
efficiency of services. While this may hold true, one of the key factors impeding competition are high
entry barriers. Licensing is one form of entry barrier. Added with the inefficiencies of the PSBs,
which is clearly reflected from the Rs. 2.67 Trillion14 of Non-performing Assets (NPA) they
contribute, the banking sector needs new private entities to reform it further. It is thus imperative to
analyse the impact of the bank licensing regime in India including the entry regulations associated.

Thus, this chapter highlights the concerns of the commercial banking sector, prominent banking
reforms over the years, issue of differential treatment of public and private banks and a special
attention to new private bank licensing and introduction of differential banking institutions. To
understand the competition and the licensing regime, it is necessary to delve into the regulatory
architecture of Indian Banking sector and how the banking reforms over the years have influenced the
current scenario.

Regulatory Architecture
The Reserve Bank of India (RBI) is responsible for the regulating the banking sector in India.
Established on April 1, 193515 in accordance with the provisions of the Reserve Bank of India Act,
1934, RBI was originally privately owned. With its nationalisation in 1949, RBI is now fully owned
by the Government of India. RBI has 19 regional offices, most of them in state capitals and 9 Sub-
offices16.

Box 2: RBI and its functions

RBI has numerous functions, which are critical to the national development and financial stability.
The major functions of RBI are (1) Formulating, implementing and monitoring the monetary policy;
(2) Regulating and supervising financial system; (3) Managing Foreign Exchange; (4) Issuing
currency; besides a wide range of promotional functions to support national objectives and acting as
a banker to the Government and all scheduled banks.
Source: Reserve Bank of India Website (accessed September 2015)

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Regulatory Reforms
Over the years there have been a number of committees/commissions constituted to bring reforms to
the banking sector. Some of them have been briefly mentioned below:

Narasimham Committee I (1991)

After the Balance of Payment (BoP) crisis in 199117, the government had to embrace economic
liberalisation. Similar reform was required for the banking sector for inclusive development of the
country. An expert committee was thus set up, under the chairmanship of Mr. M. Narasimham, for
spearheading financial sector reforms in India. The Narasimham committee recommended many
changes to the financial sector of which one was opening of banking sector for private players. The
rationale behind this was that private players would infuse competition which shall result in
enhancing efficiency in the sector, desperately needed after nationalisation setbacks. This
recommendation was accepted and subsequently in 1993, first window of licenses for new private
banks was opened.

Narasimham Committee II (1998)

After the earlier committee influenced reforms, the Narasimham committee was again laden with the
task to strengthen the financial sector further, in particular the financial institutions. The committee
report highlighted the desperate need of providing financial services to underserved and focussed on
factors like size of banks and capital adequacy ratio among others. It observed that the new private
banks, along with public-sector banks (PSB), had lagged behind on the financial inclusion objectives.
Thus the committee, of the many recommendations for financial inclusion, recommended introduction
of more private banks which was instigated by RBI in 2003 by opening second window for bank
licenses.

Financial Sector Legislative Reforms Commission (2011)

In March 2011, the Ministry of Finance constituted the Financial Sector Legislative Reforms
Commission (FSLRC)18, to clean up and rewrite the financial sector laws according to current
requirement of the country. FSLRC assessed that regulatory gaps, overlaps, inconsistencies and
arbitrages exist in financial sector because of the presence of multiple regulators.

In March 2013, FSLRC submitted a report19 to the Ministry which addressed the regulatory issues and
a draft Indian Financial Code to supplant numerous existing financial laws. On regulation of banking
sector, the FSLRC emphasised on the need of independence and accountability of the regulator i.e.
RBI. The code proposed a shift from sector-wise regulation to a differential framework where only
RBI would be responsible for regulation of banking and payment system.

FSLRC also commented on the existing legislation on banking and how it impacts ideal competition
and operations. In its Eighth Meeting, the Financial Stability and Development Council (FSDC)
approved the implementation of the recommendations which would enhance governance, and not
require legislative action at present20.

PJ Nayak Committee (2014)

In January 2014, RBI constituted a committee under the chairmanship of former Axis Bank head P.J.
Nayak, to review issues of governance in banks. The issues to be addressed included the assessment
of the level of regulatory compliances required, operational framework of different banks, suggesting
strategies for growth and risk management, regulatory guidelines on bank ownership, ownership
concentration and representation in the board, et al.21

Box 3: Recommendations of PJ Nayak committee

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 Some significant recommendations by the PJ Nayak committee were as follows22:
1. State ownership and control impacts PSBs performance. Thus, the committee
recommended keeping State only as investor and not exercising any control in PSBs.
2. It recommended repealing the different banking Acts and bringing all banks under
Companies Act, and a Bank Investment Company (BIC).
3. It recommended reduction in government stakes in PSBs to just less than 50 percent. This
was to reduce burden of vigilance and right to information (RTI) on PSBs while keeping
them State Owned.
4. The committee recommended a special vehicle, similar to a holding company, which would
have powers to make appointments of whole-time directors and directors that represent
State.
5. The committee suggested "fit and proper" criteria for governance.
6. The committee suggested a fixed term of 5 years for the chairman/managing director and 3
years for a whole-time director.
Source: Governance reforms in banks: The Nayak Committee Report, Business Today (May 20, 2014)

Indradhanush Scheme (2015)

In 2015, the Union Government released another banking reform known as Indradhanush. This
reform is intended to revamp the functioning of PSBs through a seven pronged agenda. It is yet to be
seen how this reform turns out in improving the state of PSBs but may spur efficiency of the PSBs
which have lagged behind their private counterparts and are bearing humongous amount of NPA on
their books. The seven points of the agenda were on appointments of top management; setting up
Bank Board Bureau, Capitalisation, De-stressing PSBs, Empowerment, establishing a framework of
accountability and reforming governance.23 However, P J Nayak himself has commented on
Indradhanush to be insufficient to bring major reforms to the banking sector.24

Box 4: Salient features of Indradhanush Scheme

The 7 pronged agenda of the Indradhanush Scheme may be summarised as follow:
1. Appointment: Separates post of Chairman and Managing Director in PSBs as Managing
Director and Chief Operating Officer (MD & CEO) and a non-Executive Chairman.
Announcement of appointment of MD & CEOs and non-Executive Chairmen for various
PSBs was also done.
2. Bank Board Bureau: The government shall set up Bank Board Bureau which would act as a
link between government and bank and shall monitor PSBs performance.
3. Capitalization: Infusion of a total of Rs. 25,000 crore of capital into debt-laden PSBs in
fiscal 2015-16. Over the next four years, the government plans to inject Rs 70,000 crore.
4. De-stressing: Fast processing of projects and clearances to avoid the PSB funding turning
into NPAs.
5. Empowerment: Providing flexibility to PBS on hiring.
6. Framework of accountability: New indicators to measure PSB performance were
announced.
7. Governance reforms: No State interference in the operations of PSBs.
Source: Department of Financial Services, 2015

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There have been other committees as well such as Raghuram Rajan Committee, Malegam Committee,
Tarapore Committee, Mor Committee, etc., which provided their recommendations on financial
inclusion, microfinance and other financial issues in India. One of the key recommendations of some
of the committees, starting from the Narasimham Committees, was the introduction of new private
banks in the sector and now the introduction of differential banks such as payment banks and small
finance banks in India. Private entities are being rationally given banking licenses by the RBI, which
in past has provided the much needed momentum to banking services in India and may even in the
future. The next section thus talks about the different licensing windows RBI opened.

Bank Licensing

Bank Licenses: 1st Round (1993)

Pre liberalisation scenario accounted for PSBs holding 91% of total bank branches in number and
85% of total banking business by quantum25. Based on the recommendations of Narasimham
committee I (1991)26, the first window for new private bank licenses was opened by RBI in 1993, and
applications were invited. Based on the guidelines then, ten private players were granted licenses to
operate banks in India in 1993, which subsequently started their operations in 1994-95. Not all banks
could survive the competition, which lead to 4 banks merging with others, while 6 others are still
operational.
Table 1 Bank licenses granted in 1993
Still operational Merged with other banks
1. Industrial Credit and Investment Corporation of India (ICICI) 7. Global Trust Bank
2. Housing Development Finance Corporation (HDFC) 8. Bank of Punjab
3. Unit Trust of India (UTI) (now Axis bank) 9. Centurion bank
4. Industrial Development Bank of India (IDBI ) 10. Times Bank
5. Indus Bank
6. Development Credit Bank (DCB)

Bank Licenses: 2nd Round (2003)

In 2001, based on Narasimham Committee II recommendations, RBI released guideline for the entry
of new private banks and invited applications. Private Banks had shown potential to drive productivity
and efficiency in the sector and were looked upon, to drive it further. With focus on customer
service and technology, private banks had showed considerable improvements in the economic and
financial parameters27 since their introduction in 199328. This led to improvement in overall efficiency
of the sector. However, the collapse of Global Trust Bank made sure that RBI took a more pragmatic
approach in granting licenses and thus, granted licenses to only two new banks in 2003 which started
their operations in 2003-04 viz.

1) Kotak Mahindra; and 2) Yes Bank

Box 5: Collapse of Global Trust Bank

Global Trust Bank (GTB) was granted license in 1993 in the first licensing window by RBI. GTB
went on to become a leading private sector bank in India. Since 2001, GTB's name was associated
with scams and controversies, thereby casting shadows over the credibility of the bank and its
management.

Due to the over exposure to capital markets and huge NPAs, the bank was in a financial mess. When
GTB tried to cover up its monumental NPAs through under provisioning, RBI appointed an
independent team to review the finances of the bank. The review revealed various financial
discrepancies kept covered by the bank.

RBI imposed a three month moratorium on GTB on the ground of "wrong financial disclosures" and

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within two days the bank was merged with Oriental Bank of Commerce (OBC), a public sector bank.
With the merger becoming effective, GTB's identity came to an end and it became a part of OBC.
Source: The Rise and Fall of Global Trust Bank, Case Study by ICMR, 2005

Bank Licences: 3rd Round (2013)

In 2011, the then finance minister, Pranab Mukherjee, announced the issuing of new private bank
licenses to improve the access to banking services in India. Subsequently, RBI, in 2013, released
guidelines for new bank licenses29. The new guidelines, surprisingly, allowed large business houses to
apply for banking licenses for which RBI, in earlier cases, was reluctant on. However, no business
houses were given banking licenses. The licensing attracted 26 applicants of which only two were
granted in-principle approval in 2014. These were:

1) IDFC Limited and; 2) Bandhan Financial Services Private Limited

Box 6: Licensing Guidelines of 2013

The key points of the licensing guidelines were:
Allowed Indian resident owned entities, public sector entities, existing NBFCs as well as
large industrial houses to apply.
A Fit and proper criteria to ensure credibility and integrity of applicants. 10 years of
operation experience and financial soundness mandated.
Even if the applicant met the eligibility criteria, RBI could still decide against granting
license.
The new banks could only be set up through a NOFHC (Non-Operating Financial Holding
Company), established by the promoters to hold their investments in banks. NOFHC was to
be registered as NBFC and no individual, belonging to promoter group, could hold more than
10 percent of total voting equity share in it.
Initial minimum paid up capital requirement was set as Rs. 5 billion of which NOFHC could
hold a minimum of 40 percent of paid-up capital. This capital was to be locked-in for a period
of 5 years from the commencement of banking operations.
If NOFHCs shareholding was more than 40 percent, it is to be brought down to 40 percent
within 3 years of commencement of business. Further to be brought down to 20 percent and
15 percent within 10 and 12 years respectively.
Banks were to maintain a minimum capital adequacy ratio (CAR) of 13 percent of the risk
weighted assets (RWA) for a minimum time of 3 years commencement of operations. The
banks would also need to go public within 3 years of commencement of operations.
The foreign shareholding was capped at 49 percent and could not exceed for the initial 5 years
from the date of licensing. Post 5 years, the foreign share may follow norms of the existing
policy (74 percent).
The banks couldnt invest or provide credit to promoters or any member of NOFHC. The
banks would also not be allowed to invest in capital instruments of other financial entities
under NOFHC.
A single entity or a group (apart than NOFHC) cannot have a shareholding of more than 10
percent of the paid-up voting equity capital of the bank.
The bank shall need to open 25 percent of its branches in unbanked rural centres.

Source: New banking license in India, Action Financial Service (pvt.) Ltd

The awarding of licence to a microfinance company (Bandhan) and an infrastructure finance company
(IDFC) showed the primary intention of RBI to promote banks which focus on serving the financially
excluded strata of society along with implementing a sustainable business model to keep the progress
going. Bandhan and IDFC have started their banking operations in August and October 2015
respectively.

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Comparison of Old and New Private Bank Licensing Guidelines by RBI
The perquisites for the entry of private players, for the banking industry, have been changing over the
years. The table below highlights the major differences between the last set of guidelines (2001) and
the latest guidelines (2013).

Table 2 Comparison of 2001 and 2013 new private bank licencing guidelines (Source: RBI Circulars)
Key 2001 Guidelines 2013 Guidelines
Features
Eligible The new bank should not be promoted No restriction on large industrial or
Promoters by a large industrial house business houses
Bank may only be set up through a
NOFHC
Minimum Initial: Rs.2 billion Initial: Rs. 5 billion
Equity Target: Rs.3 billion within 3 years
Capital
Criteria for Preference to promoters with expertise of Fit and Proper Criteria, sound
selection financing priority areas and financing of credentials and a 10-year track record of
rural and agro based industries running business successfully
Foreign Maximum Foreign shareholding: 40 per Maximum Foreign shareholding: 49
Share- cent percent (for initial 5 years, from the date
holding of licensing); and then 74 percent
Promoters Minimum Promoters contribution: 40 NOFHC to hold a minimum of 40
contribution per cent of the paid-up capital percent of paid-up capital
in Paid-up Capital locked-in period: 5 years from Capital locked-in period: 5 years from
capital the date of licensing commencement of banking operations
Dilution of capital in excess of 40 per Dilution of NOFHC shareholding in
cent: after 1 year of the banks excess of 40 percent: within 3 years of
operations. commencement of business. To be
brought down to 20 percent and 15
percent within 10 and 12 years
respectively.
Minimum 10 percent 13 percent
CAR
PSL30 25 per cent of its branches in rural and 25 per cent of its branches in unbanked
Targets semi-urban areas rural areas
Listing the No mandatory listing quoted (Option to Within 3 years of commencement of
Bank go public to raise capital) operations.

The new guidelines were more precise as compared to the older one; however, the eligibility criterion
for entry of new private banks has now become more stringent and demanding. Higher CAR and
minimum capital requirement, strict dilution of promoters contribution to paid-up capital, limit on
foreign shareholding et al, set the bar higher for the entry of new players than ever before. In both
rounds, a number of entities applied for banking licenses, however a handful of entities were granted
licenses.

The regulator, also, did not specify the reasons for granting bank licenses to some and rejection of
other apparently eligible entities. There appears to be no sound rationale for rejection of applications
of entities which have qualified the eligible criteria, without providing reasoned decision and
opportunity of hearing. Also, there is no redress mechanism to which rejected entities could approach.
No fear of potential entrants results in reduced competition.

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Looking at the weak performance of PSBs31, there is a desperate need of allowing more private banks
in the arena or privatising the existing PSBs and raising the entry barriers restricts the new entries.
However, RBI has also tried to bridge the gap in financial inclusion by introducing differential
banking.

Differential Banking Licenses: Payment Banks and Small Banks

Payment Banks
RBI constituted a committee headed by Dr. Nachiket Mor in 2013 to recommend innovative solutions
to accelerate financial inclusion in sustainable and cost effective way. One key recommendation in its
report, in 2014, was to introduce specialized banks (Payments Banks) to cater to the lower income
groups and small businesses. The report also provided high level criteria to assess Fit and Proper
status of the Payments bank license aspirants.

RBI, in November 2014, released guidelines on eligibility and licensing of Payment Banks. RBI
received 41 applications32 which included some big business houses as well. In August 2015, RBI
granted in-principle approval to 11 applicants to set up payment banks. These are listed in the table
below:
Table 3 Payment Bank applicants getting in-principle approval by RBI

1. Aditya Birla Nuvo Limited 6. National Securities Depository Limited

2. Airtel M Commerce Services Limited 7. Reliance Industries Limited
3. Cholamandalam Distribution Services Limited 8. Shri Dilip Shantilal Shanghvi
4. Department of Posts 9. Shri Vijay Shekhar Sharma
5. Fino PayTech Limited 10. Tech Mahindra Limited
11. Vodafone m-pesa Limited

Payment banks can accept deposits (not exceeding Rs. 1 lac), issue ATM/Pre-Paid Instruments/Debit
Cars, offer remittance services and can provide internet banking services to consumers. They can also
act as business correspondents to other banks but they cannot provide credit services. Thus, a
Payments Bank can not undertake lending activities, issue credit cards, accept NRI deposits or
become a virtual bank or branchless bank33.

Box 7: Snapshot of Payment Bank Guidelines

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Promoter Eligibility:
NBFCs, Telcos, Corporate BCs, PPI Issuers, super -market chains, companies, real sector co-
operatives and public sector entities, individuals, professionals
Partnering with a SCB
Sound track record running businesses for 5 years
Conform to fit and proper and any other criteria prescribed by the RBI
Minimum capital contribution: Rs. 400 million
Restriction on aggregate shareholding of FDI, NRIs and FIIs

Credentials:
Promoter groups should have sound credentials and integrity
Source of promoters' equity should be transparent and verifiable
Governance:
The Board should have a majority of independent Directors
Compliance with corporate governance guidelines including fit and proper criteria for Directors

Business Model:
Business model should compliant with allowed scope of activities provided in the guidelines
Focus to address financial inclusion
Adoption of technology to lower the operational costs and extend reach
Best-in class customer service proposition

Post Licence Requirements:

Bank should be fully networked and technology driven
Should have well established customer grievance cell
Maintain leverage ratio less than 33.33
CAR: 15 percent
Maintain CRR and SLR requirements
If net worth reaches Rs. 5 billion, listing and diversification of ownership is mandatory within 3
years
Source: RBI Guidelines for Licensing of Payments Bank: Opportunities and Challenges, Deloitte,
December 2014

Small Banks
In 2013, RBI published a policy discussion paper Banking Structure in India The way forward.
The discussion paper highlighted the merit in considering access to bank credit and services through
expansion of Small Banks in unbanked and under-banked regions of India. Subsequently in
November 2014, RBI published the guidelines for Small Finance Bank and invited applications. RBI
received 72 applications34 and granted in-principle approval to 10 applicants in September, 2015,
which were:

Table 4 Small Bank applicants getting in-principle approval by RBI

1. Au Financiers (India) Limited 6. Janalakshmi Financial Services Private
2. Capital Local Area Bank Limited Limited
3. Disha Microfin Private Limited 7. RGVN (North East) Microfinance Limited
4. Equitas Holdings P Limited 8. Suryoday Micro Finance Private Limited
5. ESAF Microfinance and Investments 9. Ujjivan Financial Services Private Limited
Private Limited 10. Utkarsh Micro Finance Private Limited

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The objectives of setting up of Small Finance Bank will be for furthering financial inclusion by (i)
provision of savings vehicles primarily underserved sections of the population, and (ii) supply of
credit to small business units; small and marginal farmers; micro and small industries; and other
unorganized sector entities, through high technology-low cost operations.

A Small Finance Bank can offer basic banking services (acceptance of deposits and lending to
underserved sections including small business units, small and marginal farmers, micro and small
industries and unorganized sector entities), non-risk sharing simple financial services activities not
requiring any fund commitment, such as distribution of MFs, insurance products, pension products,
etc. and the Small Finance Bank can also become a Category II Authorized Dealer in foreign
exchange business.

Box 8: Snapshot of Small Bank Guidelines

Promoter Eligibility:
10 years of experience in banking and finance. Successful track record of running business for 5
years
NBFCs, Micro Finance Institution (MFIs),Local Area Banks (LABs) permitted
Conform to fit and proper and any other criteria prescribed by RBI
Minimum capital contribution: Rs. 400 million
Restriction on aggregate shareholding of FDI, NRIs and FIIs

Credentials:
Promoter groups should have sound credentials and integrity
Source of promoters' equity should be transparent and verifiable
The Board should have a majority of independent Directors
Compliance with corporate governance guidelines including fit and proper criteria for Directors

Business Model:
Realistic and financially viable business model
Focus to address financial inclusion
Adoption of technology to lower the operational costs and extend reach

Post License Requirements:

Need to have at least 25% of branches in unbanked rural areas
75% of adjusted net bank credit to priority sector
50% of loan portfolio should constitute loans and advances of upto Rs. 25 lakh ticket size
CAR: 15 percent
Bank should be fully networked and technology driven
Shareholding by promoters in excess of 40% shall be brought down to 40% within 5 years of
commencement
Promoters stake should be brought down to 30% within a period of 10 years, and to 26% within 12
years from the date of commencement
If net worth reaches Rs. 5 billion, listing is mandatory within 3 years of reaching that net worth
Source: RBI Guidelines for Licensing of Small Bank: Opportunities and Challenges, Deloitte,
December 2014

Outlook on Payment Bank and Small Bank guidelines

RBI, like always has stressed on financial institutions to adopt technology and innovative business
models to bring the cost of providing services down and increasing outreach of financial services.
However, certain clauses in the guidelines may prove restrictive to this purpose.

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 1. To start from, the guidelines provide the objective of payment banks to further financial
inclusion. Payment banks, as envisaged by the Guidelines, enable access to formal savings
and payment services but not credit. Access to credit is an essential feature of financial
inclusion, and without it inclusion cannot be complete.
2. 5 years (payment banks) and 10 years (small banks) have been set as minimum experience
required, to prevent the entry of unscrupulous entities from getting licenses. However, in this
world of startups, the key may be held by innovative and technologically sound yet
inexperienced entities. Restricting such entries may stifle innovations in business models.
3. Further, the fit and proper criterion sets the entry barriers too high for aspirants. The
mandatory dilution of ownership by the promoters within 3 years may also repel the potential
applicants from applying for licenses as it may go against their interests.
4. The Guidelines provide that payment banks will be required to invest balance funds in
government securities/treasury bills with maturity up to one year that are recognised by RBI
as eligible securities for maintenance of statutory liquidity ratio. Payment banks must be
allowed to deploy funds in corporate bonds of reputed companies (short term AAA rated
corporate bonds), in addition to government securities. This would help them to earn
reasonable interest, thus making the business model viable. The Nachiket Mor committee
made recommendations on similar lines.
5. Lastly, RBI doesnt provide the rationale behind the number of licenses granted for payments
banks (11) and small banks (10). While there is a need to introduce more financial
institutions, RBI not keeping the decision process transparent is questionable.

Public vs. Private Sector Banks

It has always been claimed that the public and private banks are treated differentially and thus there
exists no level playing ground for all banks combined. This may be attributed to constant change in
governments stance over bank ownership (nationalising and then allowing new private entrants) or
the operational factors as different banks governed by different Banking Acts in the country.

Sector Entry
Over the years, the approach of the government on entry of new banking institutions has changed
dramatically. From nationalising private banks to allowing new private banks to the sector, the
changes have been numerous. Considering the changes, the banking scenario, over the years, may be
divided into three phases for independent India:

1947-1959
All the banks, operational then, were private. The only notable public bank during this phase was SBI,
which became public through government buying major shareholding in 1955, on recommendation of
RBI. During this time, the private banks catered to specific sections of society which left a large
population unbanked and underserved. While there was requirement for banks to enhance their
outreach for holistic growth of the country, the government was left with limited resources (public
sector banks), to drive it.

1960-1990
This phase saw all major private banks being nationalised for national interest. During this phase,
Indian Banks were working in a regulated system. Interest rates were regulated by RBI, credit was
controlled, and SLR and CRR requirements were high, which adversely affected efficiency and
financial stability. Even though there was rapid growth of deposits, profitability of banks was low.
Due to constant wearing down of capital, there were questions on the survival of the Indian Banking
System.

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Figure 1 Confused state of government on bank ownership

1991-present
Post the BoP crisis of 1991, Narasimhan Committee I recommended opening of sector for new private
players to infuse competition and efficiency. Thus, in 1993, 2003 and 2013, three different windows
were opened for new private banks to step in. The new private banks delivered the much needed
competition in the industry and PSBs have been continuously losing their market shares to them.35
Still, the entry barriers over the years have been raised considerably by RBI. The first window saw
collapse of 4 out of 10.

However the FSLRC, in its resolution says, Failure of financial firms is an integral part of the
regenerative processes of the market economies: weak firms should fail and thus free up labour and
capital that would then be utilised by better firms. However, it is important to ensure smooth
functioning of the economy, and avoid disruptive firm failure.36Despite the evident requirement of
new private entities in banking, RBI has been constantly raising the entry barriers. Thus, limiting the
private players in the sector or restricting their entry, may be deemed questionable.

Box 9: PSBs losing out to Private Banks

The following statistics provide evidences on how PSBs are losing market to their private
counterparts:
2.8% is the share in current account deposits that public sector banks (PSBs) lost in four
years, says a Morgan Stanley report
4.9% is the share in current account deposits that private banks have gained
At a rate of 1-1.5% every year, PSBs are expected to lose market share
6.1% is market share that private banks have gained in four years
120 basis points of loan market share is what PSBs have lost to private banks, according to
Jefferies
Source Business Standard, Private banks wrest market share from PSBs. July 2015

Operational Factors
Apart from the change in government strategies for the banking industry, there exist several issues
regarding the operations of the banks in India. These might be attributed to regulatory arbitrages,
ownerships and the operational frameworks. These issues hinder fair competition between the public
and private banks which is negative to consumer interests. While the PSBs enjoy certain leverages
and benefits as compared to their private counterparts, they also bear extra burden levied upon them
by the government. Thus it is essential that the government ownership should not lead to differential

12 | P a g e
treatment of private and public banks. PSBs should run professionally and compete with private sector
counterparts even when they are owned by government.

Regulatory Arbitrages
1. The PSBs are endowed with implicit government guarantee which ensures their insolvency.
Thus consumers perceive PSBs safer as compared to private banks.37
2. State bank of India (SBI) Act (1955) and SBI (Subsidiary Banks) Act 1959, governs the
working of SBI and its associates. The Private Banks are governed by the Banking
Regulation Act (1949). The Nationalised Public Sector Banks are governed by The Banking
Acquisition (1970), Banking Acquisition (1980) and partially the Banking Regulation (BR)
Act (1949). The different acts create an unduly regulatory regime different banks which may
be listed as follows38:
a. Voting rights of a shareholder in a private bank is capped at 10%, but voting rights of
a shareholder of a PSB is restricted to 1%.
b. Provisions on restructuring, suspension of business and winding up is also different
under different Acts. RBI has powers to intervene when the managing director of a
bank, governed under the BR Act, is not a fit and proper person. In case of
nationalised banks, RBI does not have such wide powers.
c. On winding up, RBI may apply to the Central Government for imposing a
moratorium for banks governed under BR Act.
d. For nationalised banks the power to order a dissolution or a merger/ amalgamation
vests solely with the Central Government.
3. Riskier PSBs, with high ex-ante systemic risk and low Tier 1 capital, have in the past
received greater capital support from the government39.
4. The Statutory Deposits for government run programmes are parked only at PSBs40.
5. There is added burden on PSBs for executing the government schemes/social initiatives, for
which even the Governor of RBI stated that the PSBs are not compensated sufficiently41.
6. PSBs cannot appoint Chief Executive and other Directors to the Board themselves42.
7. Remuneration differences and low decision making independence at public sector.

There exist imbalances in treatment of public and private banks as per existing regulation. The
FSLRC and Nayak Committee have recommended key points to eliminate these differences which are
however yet to be incorporated by the government/RBI. Based on the discussions in this chapter we
can conclude it with few learning and recommendations.

Conclusions & Recommendations

The introduction of differential banks financial services through the likes of new private banks,
payment banks and small banks is expected to enhance competition. The likely impact of the
competition might be seen on the deposit rates and credit rates, and some players might go on
adopting unsustainable rates. It might also result in innovations on products and ways of catering
consumers which might bring down the operational costs. Considering the technology upgradations
and innovations, to keep up with the competition, would have financial implications on every player
and may result in lowering of margins.

This might also be a peephole for un-ethical and other unfair practices between players, for which the
regulator, Competition Commission of India (CCI) as well as the consumers would need to stay
vigilant. However, to increase the consumer footprint, the new players as well as the old ones, would
need to venture into rural setups to hold their market positions. This is likely to impel the financial
inclusion drive of India. The other impacts would be the development of a good rural banking

13 | P a g e
network as well as some issues that could crop up regarding corporate governance of new
conglomerate-owned banks43 in case of payment banks and small banks as no business houses were
given new private bank licenses.

Box 10: Overlapping of Banking Regulations with Competition

RBI once wrote to the Corporate Affairs Ministry for exclusion of the banking sector from the
Competition Act. The request however was declined. There are a number of functions RBI performs
which overlap with the operations of the Competition Commission of India (CCI). RBI, through
Banking Regulation Act 1949, is the sanctioning authority for banking companys mergers and
acquisition. Similarly, there are other regulatory provisions exercised by RBI which overlap with
the CCI.

Whilst there could be other channels that can be used by the central bank to influence outcomes of
the banking sector (e.g., bailouts or directives on mergers), there are generally some specific issues
that are covered by specific statutory and administrative regulatory provisions, which include the
following:
Restrictions on new entry;
Restrictions on pricing (interest rate controls and other controls on prices or fees);
Line-of-business restrictions and regulations on ownership linkages among financial
institutions;
Restrictions on the portfolio of assets that banks can hold (such as requirements to hold
certain types of securities or requirements and/or not to hold other securities, including
requirements not to hold the control of non-financial companies);
Capital-adequacy requirements, normally enforced through forced or encouraged mergers;
Requirements to direct credit to favoured sectors or enterprises (in the form of either formal
rules or informal government pressure), resulting in some needy firms failing to access
credit;
Special rules concerning mergers (not always subject to a competition standard) or failing
banks (e.g., liquidation, winding up, insolvency, composition or analogous proceedings in
the banking sector);
Other rules affecting cooperation within the banking sector (e.g., with respect to payment
systems).
Source: ICN, 2005.

However, this would see an increase in pressure on the PSBs for their debt management. The
reductions of margins, fresh competition, market aggression, et al shall result in lesser budget left to
offset their NPAs. However, the banks may also strategise their debt management through increased
efficiency and cost cutting measures, but is highly unlikely to happen given the past experiences. This
may result in government infusing more money in PSBs. Even though the Government and RBI have
taken many initiatives to make the industry more efficient, there are more reforms needed to ensure
this. Some of these are as follows:

Eliminating regulatory arbitrages between private and public sector banks

Different banks in India are governed by different banking legislations. The presences of multiple
legislations, creates a non-uniform regulatory scenario for the market players which deeply stifles
competition. Ensured insolvency and the benefits enjoyed by SBI and its associates and PSBs must be
withdrawn and there should be a standard legislation for all banks in India, irrespective of their
ownership type. Tools such as Regulatory Impact Assessment (RIA) and Competition Impact
Assessment may help in evaluating the effects of the proposed and existing regulations to formulate
the most optimal design.

14 | P a g e
Ensuring Competitive Neutrality
Other than the regulatory issues, there are several other factors that limit competition in the sector.
The PSBs are laden with the responsibilities of government initiatives, which become burdensome in
terms of time and costs incurred. There is a requirement for the government to compensate PSBs
adequately for these added responsibilities.

Usually, for all government initiatives, significant funds are parked in PSBs only, which provide them
additional money to invest or to provide consumers on credit44. Private Banks never receive such
deposits which dampen the competition in the sector. Moreover the performance meltdown at PSBs
may also be associated with the performance of employees. The employees at PSBs have very less
incentives to perform well as compared to those in private banks. The salaries for PSB employees are
not even comparable to ones at private banks. Thus, there is a need to ensure effective remuneration
which shall keep the employees at PSBs competitive to the private employees which shall promote
performance.

Ensuring level playing ground for banks and non-banks

With the existing banks struggling for a level playing ground due to presence of different legislation
governing different banks, the entry of differential banking institutions might make the situation even
more complicated. This may be in terms of the regulations on the differential banks versus the
existing full-fledged banks. Just like the regulatory arbitrages exit in case of public versus private
banks, to which both entities claim imbalances in regulation, any such regulatory imbalances between
differential banking entities shall defeat the purpose of their introduction. The banks (existing and
upcoming) may face competition from the differential banks which shall strive hard to expand their
consumer base. This would involve fierce fights for existing consumer bases and well as expanding
the outreach through modern and more innovative technologies. And this competitive regime may
only be ensured by providing a level playing ground for all players irrespective of the type of bank
they belong. This needs establishment of a regulatory strategy which is not non-discriminatory
between banks and non-banks.

Transparency on licencing by RBI

RBI has come up with in-principle approval to 11 applicants for payment bank licences; 10 for small
banks and 2 for new private banks. The rationale behind the number of in-principle approvals has not
been provided neither has been the reason for rejection of applications despite meeting the entry
requirements. With RBI not providing details about the licensing process highlights the non-
transparency. Though, RBI statements suggest the licenses to be provided on the tap to show
licenses would be providing on rolling basis, but it doesnt provide reason for their actions.

Moreover, RBI deciding on the payment banks to be governed by BR Act rather than the Payment and
Settlement Systems Act, 2007, has also not been made clear. Though RBI claims that an external
evaluation committee had chosen the 11 successful applicants based on their own procedure and
analysis, the evaluation criteria too has been kept opaque.45 There is a need to make the entire process
more transparent which shall make RBI more accountable for its actions and decisions.

Provisions of statutory appeals on RBI decisions

The new bank licensing guidelines make it clear that even if an application checks all boxes of the
eligibility criteria, RBI would have the final say on providing the license. This highlights the extent of
authority that RBI enjoys in the sector. RBI is not answerable to anybody for its decisions. For all the
applications rejected for new banks, payment banks or any other licenses, the applicants can never
hope to sort an explanation from the regulator. The non-existence of statutory or regulatory rights

15 | P a g e
makes the scenario even worse for the applicants fearing the closure of doors permanently on them.
Considering the control RBI has on banking, it would be rather unwise for the applicants to go against
the regulator and better to hope things go favourable on the next opportunity. This sense of fear46
among applicants is not desirable for a sector which needs new players to achieve the much needed
financial inclusion. Thus, there should be a provision for statutory appeals on RBIs decisions. Not
only it would bring transparency but this will also imbibe the much needed accountability of RBI on
banking reforms.

16 | P a g e
Annexure I

Measures taken by Government, RBI and NABARD (Source: RBI, Economic Survey, Govt. of India, etc.)

Customer Service Centres Role of NGOs, SHGs and MFIs Financial Inclusion
Technology Fund
Credit Counselling Centres BF and BC models
Separate Plan for Urban
Adhaar Scheme Micro Pension Model
Financial Inclusion and
The National Agricultural Nationwide Electronic Financial Electronic Benefit
Insurance Scheme Inclusion System
Transfer Scheme
No-frill Account Project Financial Literacy
Financial Literacy through
Know Your Customer National Rural Financial Audio Visual medium -
Inclusion Plan Doordarshan
Project on Processor Cards
Financial Inclusion Fund SHG-Post Office Linkage
Micro Finance Development Fund
Farmers Club Program
Support to Cooperative Banks Project on e-Grama
and RRBs for setting up of
Rural Volunteers as Book Writers General Credit Card
Financial Literacy Centres

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ENDNOTES

1
Banks in India, Reserve Bank of India Website, accessed Sept 28, 2015
https://www.rbi.org.in/commonman/English/Scripts/BanksInIndia.aspx
2
A profile of Banks, Reserve Bank of India Website, accessed Sept 30, 2015,
https://rbi.org.in/Scripts/AnnualPublications.aspx?head=A%20Profile%20of%20Banks
3
Ibid.
4
Press Note dates Aug 28, 2015 on PMJDY, accessed Oct 01, 2015,
http://www.pmjdy.gov.in/Pdf/Press%20Note%20-%20PMJDY%20Anniversary%20-%2028.08.15.pdf
5
PMJDY portal, accessed Oct 01, 2015, (http://www.pmjdy.gov.in/account-statistics-country.aspx) (accounts
opened as on 26/08/2015)
6
M.Mamatha ,India / International Journal of Research and Computational Technology, Vol.7 Issue.3 ISSN:
0975-5662, May, 2015
7
Ibid.
8
Indian Banking Sector Snapshot, India Brand Equity Foundation, accessed Oct 01, 2015,
http://www.ibef.org/industry/banking-india.aspx
9
Explanatory Notes on Statistical Tables Relating to Banks in India 1979-2009, Reserve Bank of India,
accessed Oct 01, 2015, https://rbi.org.in/Scripts/PublicationsView.aspx?id=13075
10
Banking structure in India The way forward, Discussion paper by Reserve Bank of India, Aug, 2013.
11
Opening up of the banking sector to private players in 1993 and 2003 with special emphasis on the new bank
licenses of 2014 Brij Mohan University of Delhi
12
Loan Facilities for Short Term Agricultural Operations, Farmers Portal, Government of India, accessed Nov
7, 2015, http://farmer.gov.in/shortloan.html
13
Budget Speech 2014 by Mr. Arun Jaitley, Finance Minister of India
14
Source: Times of India, http://timesofindia.indiatimes.com/business/india-business/Public-banks-NPAs-up-at-
Rs-2-67-lakh-crore-in-FY-2015/articleshow/48161597.cms
15
About Us, Reserve Bank of India Webpage, accessed Oct 01, 2015,
https://www.rbi.org.in/Scripts/AboutusDisplay.aspx
16
Ibid.
17
Cerra V and Saxena S C, What Caused the 1991 Currency Crisis in India?, IMF Staff Papers Vol. 49, No. 3,
2002, International Monetary Fund, https://www.imf.org/external/pubs/ft/staffp/2002/03/pdf/cerra.pdf
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Resolution No. 18/1/2011-RE, Government of India, accessed Oct 01, 2015,
http://finmin.nic.in/fslrc/fslrc_setup.pdf
19
Ministry of Finance Website, accessed Oct 01, 2015, http://finmin.nic.in/fslrc/fslrc_index.asp
20
Handbook on adoption of governance enhancing and non-legislative elements of the draft Indian Financial
Code, Department of Economic Affairs, Ministry of Finance, Government of India December 26, 2013
21
Report of The Committee to Review Governance of Boards of Banks in India, Reserve Bank of India, 2014,
https://rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=784
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Sriram, M S, Governance reforms in banks: The Nayak Committee Report, Business Today,
http://www.businesstoday.in/opinion/columns/m.-.s-sriram-on-governance-reforms-in-banks/story/206375.html
23
Indradhanush Press Note, http://financialservices.gov.in/PressnoteIndardhanush.pdf
24
Mission Indradhanush at risk? RBI puts Indian Overseas Bank on watch due to poor finances , The Economic
Times, Oct 21, 2015, accessed Nov 07, 2015,
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Soni P and Heda B L, NPAs Impact on Financial Performance of Public Sector Banks RESEARCH HUB
International Multidisciplinary Research Journal, Volume-1, Issue-3, October 2014,
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National Institute of Bank Management Conclave on Implications of New Bank Licences
(Inaugural address by Shri B. Mahapatra, Executive Director, Reserve Bank of India (RBI) at the PG Students
Conclave on Implications of New Bank Licences at the National Institute of Bank Management, Pune on
September 28, 2013), https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?id=838
27
Speaking notes of Dr. DuvvuriSubbarao, Governor, RBI, at the FICCI-IBA Annual Banking Conference in
Mumbai on August 13, 2013.
28
Opening up of the banking sector to private players in 1993 and 2003 with special emphasis on the new bank
licenses of 2014. Brij Mohan University of Delhi
29
Guidelines for Licensing of New Banks in the Private Sector, Reserve Bank of India,
https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=2651
30
Priority Sector Lending

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31
SUPRA 21
32
Annual Report 2015-16, Reserve Bank of India
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33
Supra 9
34
Annual Report 2015-16, Reserve Bank of India
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35
Business Standard, Private banks wrest market share from PSBs. July 1,2015, accessed Nov 07, 2015,
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115070100032_1.html
36
Resolution 7.1, Report of the Financial Sector Legislative Reforms Commission, Volume I: Analysis and
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37
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38
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39
Acharya, Viral V. and Kulkarni, Nirupama, What Saved the Indian Banking System: State Ownership or State
Guarantees? (January 2012). The World Economy, Vol. 35, Issue 1, pp. 19-31, 2012. Available at
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40
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43
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44
SUPRA 35
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Financial Consumer (Depositor) Protection Reflections on Some Lingering Questions
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19 | P a g e