When Pranab Mukherjee, the then Union Minister of Finance, announced in the 2011-12 Budget that the Reserve Bank of India (RBI) would issue guidelines for fresh banking licences, it is said that nobody was more surprised than the central bank itself. Till then, the RBI was keenly pushing consolidation among banks, let alone considering the issue of new bank licences.

What followed was a tussle between the RBI and the Finance Ministry over the rulebook. The main sticking point was about large corporate entities entering the sector. The RBI wanted the rules to be framed in such a way that the door is firmly shut on large corporate houses and real estate giants in order to avoid any conflict of interest. The Finance Ministry, however, took a stand that the guidelines should not keep them out, but rather set up a barrier between owners and banking operations.

To take banking to the unbanked rural areas, the central bank has made it a strategic choice to set the bar higher. That shows that the central bank’s policies have evolved since the last two rounds of bank licences in 1993 and 2003-04. However, some questions central to financial inclusion refuse to go away, despite the RBI’s tough guidelines

The Finance Ministry had won the round. When the RBI issued final guidelines on 22nd February, it allowed a wider category of entities to enter banking, including corporate houses, public sector units and companies engaged in real estate and broking. But that concession came with many caveats. The central bank introduced stringent rules such as “vetting” the existing business model of the promoters, mandating a holding company structure and barring loans to other group entities. The central bank said it will use a “fit and proper” criteria, and has indicated that all the applicants satisfying them will not receive the licence.

Stipulating an initial minimum paid-up voting equity capital of Rs 5 billion, the central bank said only financially sound promoters or groups with a successful track record of at least 10 years can submit applications. Applicants will be allowed to open a bank only through a wholly-owned non-operative financial holding company (NOFHC). The NOFHC will hold stakes in the bank and all the other financial services entities of the group and must separate its financial services entities, including the bank, from other activities of the group.

The NOFHC must hold a minimum of 40 per cent of the paid-up voting equity capital of the bank to be locked for five years. If the shareholding exceeds 40 per cent, it should be brought down to 40 per cent within three years, and further slash its stake to 20 per cent in 10 years and 15 per cent in 12 years. Banks can get listed on stock exchanges in three years. The RBI did, however, tighten requirements with regard to exposure in promoter group companies.

The RBI has made it mandatory for new banks to open at least 25 per cent of branches in rural centres, which could make the task tougher for most aspirants. The central bank also reiterated that there will be no relaxation on norms for new banks when it comes to maintaining the mandatory Cash Reserve Ratio (CRR) or the Statutory Liquidity Ratio (SLR), and that they will have to also lend 40 per cent of their net adjusted bank credit to the priority sector.

In its clarification to the guidelines issued in June, the central bank decided to extend the validity period of the in-principle approval for setting up the NOFHC from one year to 18 months. The NOFHC is to be wholly-owned by the promoters or promoter group and it cannot be a listed company. If the promoter group, which has the financial services company listed or otherwise, wishes to set up a bank, “it must transfer all its regulated financial services business to a separate company and transfer the shareholding in such companies to the NOFHC,” said the RBI.

New Banks and Financial Inclusion

All said, the objective of the new banking licences, a decade after a few more banks were allowed to come up in the private sector, is greater financial inclusion in a nation where 40 per cent of population does not have any kind of access to formal banking. Or, in other words, expansion of banking services to rural areas. Though the central bank has very clearly spelt out the requirement of making inroads into the rural sector, experts feel it will be tough for new entrants to meet criterion of the 25 per cent branches in unbanked rural areas. The challenge is not opening a branch in these areas, but whether it can earn business from these centres.

“The 25 per cent rural presence is difficult to achieve as even the existing private sector banks are finding it hard to achieve it,” admits Deepali Pant-Joshi, Executive Director, Reserve Bank of India. “That’s why we believe Indian banks must have business and delivery models to achieve financial inclusion. You simply can’t have India and Bharat when it comes to banking,” she adds.

“The RBI will be extremely careful about the selection process, but that doesn’t mean that we don’t need more banks. Apart from expansion, the new banks will intensify competition and benefit consumers. In fact, banking and insurance are a unique space where the entry of new players has sparked competition, which, in the long term, has benefited the industry as well as consumers,” she adds.

She hoped the new entrants would add to the resilience of the state-run banks, besides deepening the government bond market. “Competition can bring down the bond yield too, helping the government to grapple with high fiscal deficits. More importantly, competition will benefit the consumers. Research and development will simplify services. Let new banks come up with business and delivery models for others to adapt,” she adds.

Viability Issues

Ashish Kumar Roy, Chief General Manager, Rural Business, State Bank of India, is optimistic about inclusion targets. “Increased competition in the regular business among banks will help inclusion,” he says. He, however, points to the viability issues that hinder the ability of banks to expand continuously. Most of the small-value accounts are inactive. “There is a chicken-and-egg syndrome banks face. Should banks open branches and employ business correspondents before or after enough economic activity is created? Which should follow what is a perennial question faced by banks. I believe there should be a viability gap funding by agencies like Nabard or the bank themselves to incentivise the rural push,” he explains.

He believes that new private banks cannot threaten public sector banking entities. “Instead of giving in to the technology-savvy modern private banks, India’s state-run banks learnt from them and got better. The key reason behind their tenacity is the government’s decision to list them on bourses simultaneously when it opened up the sector for private players. The government never sold its stake in these banks directly. Instead, the banks raised money from the public, expanded their equity base, and, in the process, the government’s stake was pared,” he adds.

R B Gupta, General Manager, Priority Sector & Financial Inclusion, Central Bank of India, highlights the need for greater financial literacy. He says at the grassroots, people don’t understand what inclusion means. “Financial inclusion and financial literacy are two sides of the same coin. In rural India, whether you like it or not, the basic problem is lack of financial literacy. We also have about 1,50,000 business correspondents employed by various banks. However, are they properly trained? Are they properly paid? The answer is, unfortunately, no,” he adds.

Bandhan Financial Services, a microfinance company, is a bank licence aspirant. Its Chairman & Managing Director Chandra Shekhar Ghosh says his experience in the industry taught him that personal touch is the most valuable asset of any banking institution. That’s how, he asserts, microfinance agencies like his have developed entrepreneurs in their customers, not just service holders. “Microfinance institutions should be recognised for the role they play in creating an army of entrepreneurs in rural India, and the credit needs of those entrepreneurs are increasing day by day. Entrepreneurship is very important to poverty alleviation. Without it, higher growth rate will remain a mirage,” he adds.

Will Financial Inclusion Still Remain a Bridge Too Far?

When the deadline for applications passed on 1st July, the central bank has received submissions from 26 entities for setting new private banks.

All said, the goal of the banking regulator is very clear. The RBI wants to take banking to the unbanked, and this time, it has made it a strategic choice to set the bar higher. That shows that the central bank’s policies have evolved since the last two rounds of bank licences in 1993 and 2003-04. Obviously, those rounds of licensing have failed to solve the problem of financial exclusion.

However, some questions central to financial inclusion refuse to go away, despite the RBI’s tough guidelines. Has customer service improved since new banks came onto the scene? How does the central bank define “rural”? If a bank open a branch in the rural suburb of a metro or a Tier-II city, will it still qualify as “rural”? This is what the private banks (which have won licences in the last two stages) seem to have done to burnish their financial inclusion credentials. This is why the idea of financial inclusion stands on its head in India. Also, will the central bank apply the same 25 per cent rural branches norm to the existing private banks?

Experts are unanimous in the opinion that the condition of having a fourth of a new bank’s branches in rural areas will hamper profitability and breakeven will take at least a decade to reach. How will the central bank ensure taking banking to the unbanked – as opposed to mere lip-service to it – against such odds? Will public sector banks continue to shoulder the main responsibility of opening more branches in rural hinterlands and building a solid current account saving account base there? If so, the very raison d’être for new bank licences will be scuppered.

Priority Sector Lending (PSL) is another grey area. According to regulations, banks have to lend 40 per cent of their loan disbursements to agriculture, micro, small and medium enterprises (MSMEs), education,housing, weaker sections and export credit. According to the central bank website, “Priority sector refers to those sectors of the economy which may not get timely and adequate credit in the absence of this special dispensation. Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections.” However, it will be interesting to know how many of the existing private sector banks meet the lending requirement set out by the RBI. In the case of MSMEs, empirical and anecdotal evidence suggests that they put so many hindrances in the way of lending to them that the total credit advanced to them is derisory.

This is why the central bank has to be judicious in handing out new licences. Tough guidelines are fine, but without a well-calibrated approach and strict monitoring, financial inclusion will remain a bridge too far, despite new private banks.

S S Bhat, General Manager, Priority Sector, Canara Bank, agrees that a lot of untapped opportunities are there in the rural areas. “Financial literacy should be seen as a necessary condition for customer empowerment. Only through expansion into the rural areas and efforts to improve literacy can people, especially those belonging to economically weaker sections, take advantage of the various services offered by nationalised banks for their socioeconomic growth,” he says.

K Ramamurthy, General Manager, Financial Inclusion, Corporation Bank, believes that for scaling up in rural areas, innovative approaches and technology are equally important. “Apart from that, to scale up in rural India, we must refine the business correspondent model. A business correspondent who is really capable of doing rural business, and whose core competency is self-help group formation, can do wonders. With the deployment of information and communication technologies and such approaches, we could do more.”

Business Opportunity in Rural Areas

Yet, there are some worthy aspirants like Bandhan and the Department of Posts which have taken the viability issue of rural operations head on and overcame them. Their experience shows that there is a lot of money ready to migrate to low-cost deposits in rural India if the banking partner is resolute in its focus. As Chandra Shekhar Ghosh remarked, there are millions of entrepreneurs waiting in the wings, and their credit needs will keep increasing day by day.

Karan Bajwa, Managing Director, Microsoft Corporation (India), opines that the new banks will not have any legacy issues on technology, which can be counted as an advantage. “Technology is one of the biggest enabling factors of financial services worldwide. The emerging cloud-based applications open awesome opportunities, and more and more services are migrating to this platform. As financial inclusion itself is being seen as a corporate social responsibility, technologies can bring a sea-change,”
he adds.

Therefore, India not only need huge delivery systems and technology that goes into making a successful modern bank but also determined players who are capable of trail-blazing efforts to reach out to poorer sections of its society, especially in markets that are very difficult to crack.

As our case studies suggest, it’s time the central bank thought out of box and calibrated its decisions on a more realistic approach to financial inclusion.

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Key Guidelines from RBI

• Private firms, public sector entities as well as non-banking financial companies (NBFCs) are eligible to set up a bank. This needs to be done through a wholly-owned non-operative financial holding company (NOFHC)
• Existing NBFCs, if considered eligible, will be permitted to promote a new bank or convert themselves into banks
• NOFHC will be wholly-owned by the promoter and will hold the bank as well as all other financial services entities of the group
• Applicants should be financially sound with a 10-year track record
• The initial minimum paid-up equity capital is Rs 5 billion
• NOFHC will initially hold a minimum 40 per cent stake in the bank for five years This will be brought down to 15 per cent in 12 years
• The bank will have to get listed on stock exchanges within three years of the commencement of business
• Foreign shareholding in the new bank is capped at 49 per cent for the first five years
• The new bank will have to maintain a minimum capital adequacy ratio of 13 per cent — that is Rs 13 capital for every Rs 100 worth of assets — for the first three years
• At least 50 per cent of the directors of NOFHC should be independent directors
• NOFHC and the bank shall not have any exposure to the promoter group. The bank shall not invest in the equity/debt capital instruments of any financial entities held by NOFHC
• The board of the bank should have a majority of independent directors
• At least 25 per cent of branches of a new bank should be set up in unbanked rural centres with a population of up to 9,999
• At the first stage, the applications will be screened by the RBI. Following this, the applications will be referred to a high-level advisory committee
• The decision to issue in-principle approval for setting up a bank will be taken by the RBI following the recommendations of the committee
• The licence will remain valid for one year

Let SEWA Do full-Scale Livelihood Banking

In the post-liberalisation era, for the third time, the Reserve Bank of India (RBI) is moving up for licensing new banks in the private sector. Earlier in each time, the Finance Ministry and the RBI have had taken a decadal span of gap before ushering the Indian banking industry into a new dynamic trajectory with its overt reformative touch.

Unlike on the last two occasions (in 1993 and 2003-04), this time the central bank has to award licences seeing the potential contenders’ urge and track record for achieving the goal of financial inclusion and not through services and technology-related ambiguous considerations.

The RBI’s upcoming policy stances would exert epoch-making effects on Indian banking. The aim of establishing few more banks for making financial inclusion a reality rather virtue is broad-based in planning. Thus the policy manoeuvrings of the apex bank should keenly match the precision of its ideation.

During the last Budget speech, the Finance Minister has announced an all-women bank. As a concept, it was good had it looked on an existing institution like the Self Employed Women’s Association (SEWA) for an alternative route to channelise the same kind of banking. With a fund corpus of `10 billion, SEWA could be turned into a full-fledged bank, with improved ability to serve the end beneficiaries all across the country.

For over four decades, SEWA is known for its remarkable works in livelihood creation among the urban and rural poor women. It is an organisation of poor, self-employed women workers—under the selfless and abled leadership of Ela Bhatt. She and her institution have made exemplary changes for the downtrodden, and all through entrepreneurial zeal and transparent institutional mechanism.

Ela Bhatt famously said that poverty is violence. This is a sort of violence by silent social accord that lets other human beings go without roti, kapda and makaan. Apparently, this is because of entitlement deficit in banking, known through the spectre of financial exclusion. This prohibits the prospects of livelihood and keeps marginalisation pervasive. The true idea of financial inclusion should be to bring the changes here at the bottom level.

Now hopefully, banking has to be people-centric and running on an inclusive business model even with all its compulsions. SEWA could not be seen as an ideal platform for an all-women bank but the RBI can give it licence (with initial capital support) for full-scale banking. This would be helpful in shaping millions of lives with better livelihood and outreach of SEWA. With half of its population unbanked, India cannot rely on the hyped wisdom of corporate banking, which even after two decades of presence, has no vision to tap the unlimited potential lying with those on the fringe. Overlooking this angle would keep the financial inclusion drive down-spirited and distracted from real issues.So, this time, the RBI should award all bank licences to the contenders who have a taste for banking with the poor. The mandate of new bank licensing clearly marks the same. SEWA will be one among the genuine players which will make financial inclusion into a sustainable business idea. The RBI must set a good example by believing in SEWA’s deserving claim of mainstreaming banking for the marginalised.

The Case for Post Bank of India

This time, the RBI has set a clear mandate of financial inclusion regarding bank licences. This would be the core business idea in the offing for new banking entities. Further consideration should also be centered on strict compliance to priority sector lending, which hitherto has fallen off due to the half-hearted participation of several private and public sector banks.

Amidst the mismatch of perception and action on financial inclusion, if the central bank were to choose one state-run entity to do so, it should be the 159-year-old India Post. The fact that it had 1,54,822 branches across the country as on 31st March — and at 139,086, close to 90 per cent of them in rural areas — makes it the best qualified to become a bank under the new licensing plan. The number of India Post’s rural branches is more than four times of total rural bank branches in India.

Post offices have been offering saving products for decades and banking would be a natural progression. A Post Bank of India, converging the existing postal life insurance (as on March 2010, 42,83,302 policies and its arm, Rural Postal Life Insurance, with 99,25,103 policies and sum assured of `595,72,59,00,275) and micro-remittance services of the Department of Post (DoP), would be a force to reckon with.

With its vast network among rural masses, India Post clearly has an unmatched edge and it will be helpful in channelising the financial products by it in further course. For meeting operational challenges ahead, a certain number of post offices can be converted into full-fledged bank branches with the focus of that potential Post Bank turned to unbanked segments and credit-starved micro enterprises. This will benefit rural areas enormously.

Also, no additional capital cost of infrastructure building will be required in making post offices as business points for banking services. The DoP has a balance sheet of over $10 billion, which includes deposits of around 90 per cent.

The department is in the process of setting up 1,000 ATMs and achieving the core banking project by 2014. As per data shared with Parliament, there were over 260 million operational small savings accounts in post offices on 31st March 2012, wih deposits worth over $3.16 billion.

In order to provide the best-in-class customer service, deliver new services and improve operational efficiencies, the DoP has undertaken an end-to-end IT modernisation project to equip itself with requisite modern tools and technologies. It has undertaken a quality improvement project called Project Arrow to transform India Post into a vibrant and responsive organisation.

Though India Post does not directly invest in government bonds, it will not face hurdles in fulfilling the statutory requirement of buying government bonds as it has been contributing to the consolidated fund of India. Only a part of that fund corpus has to be converted into government bonds.

Mass banking can happen efficiently and on a rational cost structure through making post offices a gateway to banking. In that case, every nook and corner of this country will see banking services coming around easily.

The DoP is competing with smart contenders for a bank licence and it’s far from certain if it will win it. Yet, it’s not hard to see financial inclusion from the ground up if it succeeds.

List of Aspirants

• Aditya Birla Nuvo Ltd, Mumbai
• Bajaj Finserv Ltd, Pune
• Bandhan Financial Services Pvt. Ltd, Kolkata
• Department of Posts, New Delhi
• Edelweiss Financial Services Ltd, Mumbai
• IDFC Ltd, Mumbai
• IFCI Ltd, New Delhi
• Indiabulls Housing Finance Ltd, New Delhi
• India Infoline Ltd, Mumbai
• INMACS Management Services Ltd, Gurgaon
• Janalakshmi Financial Services Pvt Ltd, Bangalore
• JM Financial Ltd, Mumbai
• LIC Housing Finance Ltd, Mumbai
• L&T Finance Holdings Ltd, Mumbai
• Magma Fincorp Ltd, Kolkata
• Muthoot Finance Ltd, Kochi
• Reliance Capital Ltd, Mumbai
• Religare Enterprises Ltd, New Delhi
• Shriram Capital Ltd, Chennai
• Smart Global Ventures Pvt. Ltd, Noida
• Srei Infrastructure Finance Ltd, Kolkata
• Suryamani Financing Co Ltd, Kolkata
• Tata Sons Ltd, Mumbai
• Tourism Finance Corp of India Ltd, New Delhi
• UAE Exchange and Financial Services Ltd, Kochi<