16th MAY 2016
Answer questions in NOT MORE than 200 words each. Content of the answer is more important than its length.
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GS III : ECONOMY -BANKING
1. Elaborate on universal banks and different types of differentiated banks. The RBI has issued norms for on-tap licensing recently? Will they prove to be effective? Analyse.
In 2014, RBI allowed universal banking licences to two entities, infrastructure financier IDFC and micro lender Bandhan Financial.
In 2015, RBI granted licences to 11 entities to start payments banks and 10 entities for opening small finance banks.
Eleven new banks were licenced to start operations as payments banks where the main objective is to provide remittance services, apart from distribution of simple financial products like insurance and mutual funds. This was also the first time business houses are allowed in banking, albeit, the scope of activities was restricted. Reliance Industries, Aditya Birla Group, Vodafone, Bharti Airtel, were some of the players that were awarded payments bank licence.
Ten new small finance bank licences were also granted, of which eight of them are micro-finance institutions. Small finance banks are mandated to extend small loans mainly to customers who are not covered by formal banking system.
Other differentiated banks such as custodian banks and banks concentrating on wholesale and long-term financing are been considered too.
Wholesale banks are lenders that cater to large corporates which require long-term finance, particularly those engaged in infrastructure development. Typically, these banks raise long-term funds which are exempted from maintaining regulatory requirements like cash reserve ratio and statutory liquidity ratio.
Custodian banks, on the other hand, are specialised financial institutions mainly responsible for safeguarding a firm’s or individual’s financial assets, and are typically not engaged in conventional retail lending.
DRAFT NORMS FOR ON-TAP LICENSING POLICY:
Ever since the Indian financial sector was opened up in 1991, the gates to allow a private entity to start a bank were opened only three times. The ‘stop & go’ approach has finally given way to a continuous or ‘on-tap’ licensing regime with the Reserve Bank of India (RBI) announcing draft norms for such a scheme. Comments are invited by June 30, after which the final norms will be released. RBI plans to make differentiated licences on tap also.
The Reserve Bank of India (RBI) draft norms for on-tap licensing for universal banks, set stiff conditions for industrial houses that aspire to become banks.
- While the broad contours of the norms are in line with guidelines issued for bank licensing in 2013, the central bank has now made it clear that business houses predominantly in financing activities, for example, non-banking financial companies (NBFCs) would be preferred.
- “Groups in the private sector that are ‘owned and controlled by residents’ and have a successful track record for at least 10 years, provided such a group has total assets of Rs. 5,000 crore or more, and the non-financial business of the group does not account for 40 per cent or more in terms of total assets/in terms of gross income,” RBI said, regarding eligibility of the promoters. Preference will be given to promoting entities having diversified shareholding, it added.
- Individuals can also apply for a licence but they should have at least 10 years of experience in banking and finance.
- The central bank has allowed individuals as well as companies who are directly or indirectly connected with large industrial houses tohave 10 per cent stake in a bank, as compared to 5 per cent earlier.
- However, the regulator said such companies should not have such shareholders should not have any director on the board of the bank on account of shareholder agreements or otherwise.
§ Regarding the corporate structure, it is proposed that individuals or standalone promoting entities need not have a non-operating financial holding company structure (NOFHC), but this is mandatory if the promoter entities have other businesses. The NOFHC, which will be registered with RBI as NBFC, will hold the bank as well as the other financial services companies of the group.
§ The NOFHC will not be allowed to set up any financial services companies for three years from the date it commences. Promoters’ minimum stake in the NOFHC will be 51 per cent.
§ The promoter (or NOFHC, as is the case may be), should have 40 per cent equity in the bank which will be locked in for five years, from the date the bank starts business, RBI said. In case promoters (or NOFHC) hold more than 40 per cent, then it has to be brought down over five years.
- The initial capital requirement for opening a bank is set at Rs. 500 crore and the entity have to maintain 13 per cent capital adequacy ratio for three years. The entity has to maintain a net worth of Rs. 500 crore at all times.
- The RBI also mandated that promoters’ stake be brought down to 30 per cent over 10 years and to 15 per cent over 12 years.
- The bank has to list its shares on the stock exchange within six years.
- The bank shall maintain arm’s length relationship with Promoter / Promoter Group entities, and the major suppliers and major customers of these entities,” the draft norms said.
ISSUING OF LICENSES:
- The central bank said licences would be issued on a selective basis to those who are likely to conform to the best international and domestic standards of customer service and efficiency and it may not be possible for RBI to issue licences to all the applicants just meeting the eligibility criteria prescribed above.
- RBI will set up a standing external advisory committee (SEAC), comprising eminent personalities, to vet the applications. The SEAC will, in turn, submit its recommendations to RBI for consideration.
- RBI will put out the name of entities that have applied for a licence and also of successful candidates in the public domain.
- The regulator will also inform the unsuccessful candidates about the decision.
- Unsuccessful candidates will not be allowed to apply within three years of rejection.
- The unsuccessful candidates can appeal against the regulator’s decision to the RBI’s central board of directors within one month of rejection.
Banking aspirants have raised a few questions on the draft norms and said they would seek clarifications from the regulator.
External committee needed?
The RBI had said it would form a standing external advisory committee (SEAC) that will vet the applications after the initial screening is done by central bank staffers. The committee is to have a three-year term and will comprise eminent personalities from the banking, financial and other relevant sectors.
This has baffled prospective applicants and former bankers. The RBI had set up similar committees during the earlier round of the licence process for universal banks as well as for niche banks.
It was argued the last round, in which IDFC and Bandhan, obtained licences in 2014, was carried out almost after a decade (the licensing process itself took more than four years), and that the RBI may not have the required skill set to vet applications which came from a wide variety of institutions – from micro lenders to complex business conglomerates. So, the external committee, consisting of a former RBI governor, a former Securities and Exchange Board of India (Sebi) chairman and an RBI deputy governor, was set up to guide the regulator.
“The RBI grants licences to primary dealers, non-banking finance companies and even to foreign banks to operate in India, without any external help. So why do they need a committee only for domestic bank licences?” asked a senior banker on the condition of anonymity.
Examples of other financial sector regulators were also cited – the Insurance Regulatory and Development Authority of India (IRDA) and SEBI, which also offer on-tap licences to insurance companies and stock brokers, without any external help. “Now that on-tap licensing has been proposed, the RBI should set up a separate department to look into only licensing issues,” said the chief executive of a firm that had applied for a bank licence earlier.
The central bank has tried to make the process on-tap licensing process transparent. For example, for the first time, it has allowed unsuccessful candidates to appeal to the central board of the RBI. Unsuccessful candidates can also apply again, after three years from the date of rejection.
While the RBI has said it will communicate its decision to the unsuccessful candidates as well, it has not specified any timeframe by which a licence will be awarded or declined. The last time around, applicants felt that the process was rather prolonged. While the entire process took over four years (it started with the Budget speech in February 2010 and ended with the grant of licences in April 2014), it took RBI more than a year to decide, after the final norms were announced. The year 2014 was also an election year. Allegations flew fast and thick as to the timing of the grant – whether they should be announced before or after the general elections. “The RBI has said that they would communicate to us if our applications are rejected. But when? We cannot wait for eternity,” said a prospective applicant.
Reasons for rejection?
Applicants from past rounds feel that the central bank, known to be a conservative regulator, seldom communicates the cause for rejection. During the recent universal bank licence process, the central bank had rejected over 20 applications, but did not communicate the reason for rejecting those applications, it is learnt. The same was repeated for differentiated bank licences where more than 90 applications were rejected. “They did not tell us why our application was rejected. This would have helped us understand the shortcomings, from the regulatory point of view,” said an applicant whose payments bank application was rejected. There is a demand from bank aspirants, in order to ensure transparency, that the central bank should make public reasons for rejecting bank licence applications.
Not to all eligible?
In the draft norms, the RBI had said entities or individual promoters would be found be fit and proper if they had 10 years of banking experience or running their respective businesses, sound credentials and integrity, sound financials, and diversified shareholding pattern among promoting entities. At the same time, the regulator said, “Banking being a highly-leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements…it may not be possible for RBI to issue licences to all the applicants just meeting the eligibility criteria.”
Prospective applicants said if the objective is to allow financial services to reach the remotest part of the country, adding only a few banks will not solve the problem.
“The licensing process should be rule-based and not discretion-based. If the applicant meets the eligibility criteria, it should be awarded the licence. That is why it is all the more important that RBI should spell out why an application is rejected,” said a prospective applicant.
Why not business houses?
It is clear from the guidelines that the central bank wants entities that are predominantly in financial services. Diversified business houses such as the Tata group, Birla group and the Mahindra group had earlier applied for bank licences (The Tata group had withdrawn its application later). Many of these groups may now find themselves ineligible because the regulator has stipulated that “the non-financial business of the group does not account for 40 per cent or more in terms of total assets / in terms of gross income.”
“The big change in guidelines comes in the form of excluding large industrial houses from being promoters, and cap their shareholding to 10 per cent,” Jefferies Equity Research said in a note.
It is learnt that the central bank had also taken note of the challenges in the insurance sector, which was opened up more than 10 years ago to the private sector. Compared to peers, India’s insurance penetration is still low. Further, with the increase in the foreign direct investment cap, many promoters in insurance are cashing out, indicating poor interest in the sector over the long-term.