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BW Businessworld

On RBI’s Sense And Sensibilities

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The much awaited document has arrived — a 19-page note from the Reserve Bank of India (RBI) dated 22 February 2013, setting out the guidelines for the licensing of new private sector banks. Having read it through most of the day, I must admit that it is well drafted. Let me outline its key elements and then raise some issues.
Resident Indian private sector entities or groups will be permitted to promote commercial banks. Subject to several caveats. For one, the promoters should be ‘fit and proper’ applicants with financially and ethically sound past records; should have successfully run their business for at least a decade; should have a working culture that is not misaligned with banking; and shouldn’t have blots on their biodata because of tax or CBI investigations and the like. 
For another, the promoters will be permitted to set up a bank only through a wholly-owned non-operative financial holding company (NOFHC). What’s that? The NOFHC is a ‘step-up’ holding body which will have in its fold the bank and other financial service entities of the promoter group that are regulated either by the RBI or other financial services regulators such as the Sebi or the Irda. It will be registered as a non-banking financial company with the RBI and subject to its scrutiny; and at least half of the board of the NOFHC and the bank shall comprise independent directors.
The idea is that the NOFHC should ring fence the bank as well as other regulated financial services of a promoter group from its non-regulated activities. It goes further. To protect the bank from other regulated financial sector activities of the group such as mutual funds or insurance, the guidelines state that financial service entities whose shares are held by the NOFHC cannot be shareholders of the NOFHC. Moreover, no non-banking financial services entity belonging to the NOFHC will be allowed to engage in banking activity. 
There are other restrictions on the bank and the NOFHC to prevent activities that might be deleterious to banking. For instance, the bank can neither lend to nor make investments in the promoter’s entities, individuals belonging to the promoter group or firms within the NOFHC. Nor can it invest in equity or debt instruments of any financial entity within the NOFHC. Nor, too, can the bank invest in the equity of any other NOFHC.
The minimum paid up voting equity capital for such a bank is pegged at Rs 500 crore; and the NOFHC must hold at least 40 per cent of it for five years. If an NOFHC holds bank shareholding over 40 per cent — as it typically will in the beginning — it must bring it down to 40 per cent within three years of the bank’s starting its business. This has to be reduced to 20 per cent of voting equity in 10 years; and to 15 per cent in 12. The bank must be listed in three years. 
There are restrictions on foreign shareholding. Although the aggregate foreign ownership of FDI, FIIs and NRIs in our existing private banks is allowed up to 74 per cent of voting equity, the RBI has chosen to limit this to 49 per cent for the first five years of the life of a new private bank. 
Now for the issues. First, I would have preferred the bank to be allowed to raise foreign shareholding to above 49 per cent but less than 75 per cent after two years. Why capital constrain it for five years? Second, there will be difficulties in maintaining a quarter of the branches of new banks in unbanked rural areas with population less than 10,000. You can have innovative mobile banking intermediation in such areas; but to expect such tiny branches to earn their cost of capital is heroic. Third, the bank applications will be vetted by a high-level advisory committee set up by the RBI. Let us hope that it is made up of best-of-breed people, who can equally see the promise of the future as they can the risks of reputation. 
Based on the note, I’ve made my private list of which groups will pass muster, and which won’t. But that’s a private list.

The author is chairman of CERG Advisory.


(This story was published in Businessworld Issue Dated 25-03-2013)