Evolving Structure of Commercial Banking in the Next Decade

As of March 2012, the aggregate deposits of all commercial banks amounted to Rs 64.5 trillion of which public sector banks accounted for 77.5 per cent and other banks for 22.5 per cent (of which old private sector banks accounted for 4.9 per cent, new private sector banks 13.3 per cent and foreign banks 4.3 per cent). If public sector banks grow at 15 per cent per annum and all other banks grow at 20 per cent per annum, at the end of ten years, the public sector banks would account for 70 per cent of the total and other banks would account for 30 per cent. If the public sector banks grow by 15 per cent per annum and the other banks grow at 25 per cent per annum, at the end of ten years, the public sector banks would account for 60 per cent of the total deposits and the other banks for 40 per cent. Thus, the public sector banks will still predominate in the Indian banking system.

Strengthening Public Sector Banks

With the growth of the public sector banking system and the implementation of the Basel III norms, the drain on the government of providing additional capital in the next five years could be of the order of Rs 9,000 billion. There are various imperative claims on the resources of the government and there is a need to moderate the demand by banks on the fisc. The Narasimham Committee II, the Percy Mistry Committee and the Raghuram Rajan Committee all recommended reduction in the share of the government in public sector banks but governments of different hues have all rejected any movement away from the 51 per cent minimum government ownership.

Under the present arrangements, the government pours in proportionately more capital into the weaker banks and as such the strength of the public sector banks is determined by the weakest bank. Serious thought needs to be given to revamp the allocation of government funds to these banks.

One alternative would be to earmark the dividend paid out by a bank to be ploughed back as additional capital to each bank and the government should refrain from providing additional capital beyond the dividend paid out. Under such a capital allocation and the cast in stone 51 per cent minimum government ownership, would imply that the well performing public sector banks would grow faster than the poorer performing banks and, as such, the overall system would strengthen. The weak banks would veer to ‘narrow banking’, i.e., these banks will have to deploy their resources into the lower risk assets. While today, the ‘narrow banking’ concept is rejected by the authorities it is worth recalling that the turnaround of a number of weak public sector banks in the 1990s was precisely attributed to ‘narrow banking’.

The Department of Posts has appointed the international consultant Ernst & Young to prepare a project report. Since it is not intended to adopt the overseas model of say the UK, Germany or Japan, and the ground realities are to be taken into account, local consultants should be also associated with this project

Persisting with the present system of capital allocation (i.e., more capital to weaker banks and less capital to stronger banks) will result in endemic weakness of the overall public sector banking system. Banking is a hard-nosed business and the government cannot afford to allocate more capital to weak banks.

Licensing of New Private Sector Banks

After an extensive iterative process of internal examination and external consultation the Reserve Bank of India (RBI), on 22nd February 2013, announced comprehensive final guidelines for licensing of new private sector banks. The last new private sector bank was licensed in 2001 and there is a pent up demand for bank licenses. It should, therefore, not be surprising if there are a large number of applicants. Potential applicants are to submit their applications on or before 1st July 2013, which will be screened by the RBI and then referred to a High Level Expert Committee. The RBI and the Committee would do well to ring-fence themselves and issue licenses only after due diligence.

The central issue of debate has been whether industrial houses and other business groups should be allowed to set up commercial banks. The advice of eminent international experts like Joseph Stiglitz as also the International Monetary Fund (IMF) has been that industrial houses should not be allowed to set up commercial banks. To the credit of the government and the RBI they have not buckled under such advice. Having allowed industrial houses to set up insurance companies, non-bank finance companies and mutual funds, there is no reason for debarring them from commercial banking.

The decision to licence new private sector banks is, in many ways, a momentous decision. First, industrial houses would have the resources to set up well capitalised commercial banks. There are adequate safeguards in the Guidelines to avoid the pitfalls of connected lending and concentration of activity. Secondly, the new private sector banks set up since 1993 have, in a sense, enjoyed an easy run in terms of competition. The new private sector banks now proposed to be licensed would, in the course of the next few years, give severe competition to the existing batch of new private sector banks. Thirdly, the new banks now being proposed to be licensed would be able to extend their reach into the rural areas – some industrial houses have been able to develop their retail network across the length and breadth of the country. It is precisely for this reason that I have for long been an advocate for granting bank licenses to industrial houses. Applicants which have an inherent advantage of reach would be potential cases for favourable consideration as they would foster the objective of financial inclusion Fourthly, some of the large public sector units which would now be eligible to apply have developed financial acumen which would be the envy of the best of the existing commercial banks.

There is no particular advantage in licensing only very few banks. On the contrary, there is merit in licensing a somewhat larger number of applicants which fully meet the criteria set out.

A corollary to the new Guidelines should be that the private sector banks set up after 1993 should be required to adhere, in toto, to the new Guidelines. After all, the 1993 Guidelines imposed onerous conditions on the old private sector banks. There is no reason why the post 1993 new private sector banks should be allowed to enjoy rentier income.

Postal Bank

The issue of setting up a Postal Bank has been under consideration as far back as 1987, but there has been a reluctance in government to setting up of such a bank. Under the present arrangement, all collections of the Postal system are transferred to the government and all claims on the Postal system are debited to government account. It was felt that if a separate Postal Bank was set up, very large amounts would need to be released to the Postal Bank which would adversely affect the Union Budget. This matter can be easily resolved. As on a cut-off date, all postal savings schemes with specified maturities could be earmarked as government liability and these could be met by government on maturity as per the present arrangement. Future collections by the Postal Bank would be the liability of the Postal Bank. The outstanding balances in the Post Office Savings Bank accounts, as on the cut-off date, would be the liability of the government. With the issue of special securities by the government to the Postal Bank, with a range of maturities, at a rate of interest slightly above the Post Office Savings Bank interest rate, the liabilities would be that of the Postal Bank. With these arrangements, there would not be any significant impact on the government budget.

As part of its commitment to financial inclusion the government should fast track the setting up of the Postal Bank as a commercial bank in 2013-14. There are 155,000 post offices of which 90 per cent are in the rural areas. Of the 93,000 commercial bank branches 37 per cent are in the rural areas.

The Postal Bank could admittedly face political economy pressures to undertake large lending. It should be stipulated that lending activity would be undertaken very gradually in consonance with the Postal Bank developing adequate lending capabilities.

The Department of Posts has appointed the international consultant Ernst & Young to prepare a project report. Since it is not intended to adopt the overseas model of say the UK, Germany or Japan, and the ground realities are to be taken into account, local consultants should be also associated with this project.

Setting Up of a Public Sector Women’s Bank

The Budget for 2013-14 has a provision of Rs 10 billion for capital subscription for the setting up of a public sector Women’s Bank, A panel, with M B N Rao as Chairman, has been set up to work out a blueprint for the bank which is to be operational by November 2013 with a start of six branches. The concept of a Women’s Bank is an excellent idea but the modalities need to be reconsidered.

Should there be one more public sector bank run by women to exclusively undertake banking operations for women? Alternatively, should there be a National Women’s Bank as an oversight agency to monitor operations relating to women by all commercial banks, cooperative banks and Self Help Groups and should the bank also undertake refinancing operations? The downside risk of setting up a public sector Women’s Bank would be that there can be a dilution of efforts by other public sector banks.

It would be reasonable to direct all banks to convert one per cent of all branches of commercial banks to all women’s branches within a year; this would result in 930 such branches. In contrast, a single public sector bank for setting up 930 such branches will take several decades.

While a new women’s public sector commercial bank being operative by November 2013 would make terrific grandstanding, undue haste could be damaging.