Banking sector needs new players
By Anjan Roy
India’s public sector banks have made huge strides since the days of nationalization. They now handle unrecognizably large deposits compared with the pre-nationalisation days; they have far greater resilience in terms of capital base and own funds; they are offering varied products to their customers; and, the public sector banks handle no less than 80% of all banking transactions in the country.
Although there are 29 PSBs, in a way they are all same and the virtual monopoly of the public sector in India’s banking scene is giving rise to demands for greater competition. It is in this context that the former governor of Reserve Bank and currently chairman of the Prime minister’s economic Advisory council, Dr C. Rangarajan, observed last week that Indian banking needs greater competition. That means we need to open up the banking industry window a little more to allow fresh players.
On Tuesday this week, the Reserve Bank governor, D Subbarao, raised the topic of entry of new banks once again at a conference in Mumbai. He had expressed his reservations about “self-dealing” by private corporate promoters if they are allowed to promote new banks. There are very many other concerns as well, such as, the conflict of interests between bank shareholders and depositors. While shareholders will prefer risk taking for higher gains, bank depositors will surely ask for safer investments to safeguard their money in the banks. The cases of some of the big banks which faced bankruptcy in course of the financial melt-down are illustrative of the dichotomy of interests.
The idea of giving new bank licences and admitting new banks has been in the air for at least a year now. Exactly a year back, in August 2010, Reserve Bank had released its “Discussion Paper on New Bank Licences” inviting comments on the policy issues relating to allowing fresh players into banking. Easy say that after over forty years it is time to admit new banks, this is fraught with grave concerns as well. After all, banking is not like any other industry. Financial sector plays a critical role in the economy and any disruption in any part of the financial architecture of an economy can have impact on the entire economy. The recent history of financial melt down in the developed economies once again is a grim reminder.
Before giving licences for new banks, some fundamental policy matters will have to be decided, taking into account the overall interests of financial stability, bank depositors interests and ways of stopping any misuse of funds. The Reserve Bank’s discussion paper lists six major areas where such conflicts will have to be resolved before allowing entry of new banks. These are a) minimum and maximum capital requirements for new banks and promoters’ contribution; b) minimum and maximum caps on promoters shareholding; c) foreign shareholding in new banks; d) should private corporate be allowed to float new banks; e) should existing non-banking financial companies be converted into banks and lastly f) new business models for banks.
While the discussions paper had examined in detail the pros and cons of each of these subjects, the most sensitive issues are whether private corporates should be allowed to float new banks and what should be their voting shares. When governor Subbarao referred to possibilities of “self-dealing” he was making a pointed reference to such collusion in the event of allowing private corporate entry into banking. Currently, the provision is that a bank cannot give loans or have transactions with an entity in which any of its directors is interested. Thus, if a company does not have a common director with a bank which it is promoting, there is no bar to the bank giving it funds. This is self-dealing. This can go against the interest of say banks depositors. Capturing the essence of the problem Mr Subbarao observed: “By far the biggest apprehension is about self-dealing”.
Private corporate promoters can further hide any self-dealing through an elaborate structure of cross holdings and corporate structures. The promoted banks could therefore turn into private pool of funds for corporate purposes. There would be no harm as long as things are going fine. However, in times of crisis unless funds are spread among a wide variety of private companies risks tend to get concentrated. Therefore too much funds into a single or handful of groups become vulnerable to the fortunes of these limited borrowers. Banks can fail with such corporate. This would spell disaster for the individual depositors.
At the same time, if the private corporates are debarred from floating banks, there might be very few serious promoters who can float a really sound new bank. For one, banks cannot be floated with small core funds as equity. A new bank must start with a sufficiently large capital base to be a meaningful player. Such funds could come only from large corporate houses not from any other sources. It is well know that large houses including the Ambanis, Aditya Birla Group, Tatas are all in the running for banking licences. Of these, Tatas had at least one large bank at the time banks were taken over by the government in late ‘sixties. So also had the Birlas which had the third largest bank in their stable at the time of nationalization.
It new private sector banks are to be allowed, it looks inescapable that private corporate should be allowed to float them. Hence, what is needed is to introduce fool-proof rules and regulations for securing water-tight segmentation of banking activities from other activities of a group. The requirements of an arm’s length segregation will call for changes in the current laws and more stringent rules have to be put in place than only bar on common directors. Besides, RBI’s supervisory powers will also have to be augmented to go into the accounts and funds flows of group companies.
The other ticklish issue would be the one for voting shares. Currently, whatever is the shareholding, voting is limited to ten pre cent. This might sound anachronistic and there is a proposal to increased voting strength to shareholding. That should b e in accordance with corporate democracy as well. This is also linked to the question of allowing private corporate to float new banks. At any rate, we need to solid homework before opening up banking further. Need for stability of the financial architecture and security of the depositors is more important than introducing new experiments for the sake of it. (IPA Service)