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The Great Bank Race

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You have a Rolls Royce, a Bentley, and a BMW in your garage. Now, you want a bank. It seems many see a banking licence as a passport to El Dorado,” says Romesh Sobti, CEO and MD of IndusInd Bank. But he concedes that “it is the view of an old-timer”. Ajay Srinivasan, CEO of Aditya Birla Financial Services Group (ABFSG), wants to be a gen-next banker. “We are under-banked,” he says. For the Birlas, nostalgia beckons: the Kolkata-based UCO Bank was a family concern — set up by Ghanshyam Das Birla in 1943 — prior to nationalisation in 1969.

You don’t get much by way of the bankable these days, but a banking licence? Woe will befall an India Inc marque if it were not to queue up at Mint Road’s gates in south Mumbai’s Ballard Estate. The Birlas, the Tatas, hamara Bajaj and Anil Ambani join a clutch of non-banking finance companies (NBFCs) of varying vintage and pedigree — Shriram Capital, LIC Home Finance, IDFC, L&T Finance, JM Financial, Indiabulls, Religare and Edelweiss — in the race for one. On 1 July, the deadline to submit applications for new banking licences, the total number of submissions added up to 26; it is a round number, but a few squares also think they fit in.

Ten licences were greenlighted in 1993; two more in 2003. Of the first lot, five banks are still around — ICICI Bank, HDFC Bank, IDBI Bank, Axis Bank and IndusInd Bank; plus an upgrade from an urban cooperative bank, Development Credit Bank. Others could not keep up. From the second lot, both are at the crease — Kotak Mahindra Bank and Yes Bank. But what this survival rate of 58.33 per cent does not tell you is that after two decades of existence, the share of new private banks in deposits and assets is barely 15.2 per cent and 15.7 per cent, respectively. What’s surprising is that despite regulatory curbs on growth, foreign banks (or global private banks) have not fared badly: at 6.8 per cent share of deposits and 7 per cent of assets.

We have 1,789 banks in India — 27 state-run; 21 private (seven new, 14 old); 41 foreign banks; 82 regional rural banks; and 1,618 urban cooperative banks. Says Vishwavir Ahuja, CEO and MD of Ratnakar Bank: “‘Islands of banks’ were created in the hope that they will address a particular segment’s needs, but the experiment has failed.” Can a handful of new banks do what all those who make up the numbers couldn’t by way of financial inclusion 66 years after Independence?
ABFSG’s Srinivasan says, “It tells you of the opportunity we have. The success of some NBFCs is testimony to it.” “The understanding the Aditya Birla Group has of Greater India through its various businesses is unparalleled,” he adds. Monish Shah, director at Deloitte Consulting, feels that when a new lot of private banks signs up for business, it will push existing banks to gird up their loins. “The same happened to state-run banks in the mid-1990s. The market share (of private banks) will change,” says Shah.

It’s perhaps a sign of the times we live in. The Reserve Bank of India’s (RBI) entry norms for private banks for both the earlier rounds was just a page long; it runs into 20 pages now. Add the discussion paper, the draft and clarifications, and it’s 237 pages. There are 127 pages of clarifications; 34 individuals and entities had posted 443 queries, which the RBI replied to. An uncharitable view is that Mint Road’s “diligent response” was aimed at keeping a lot many at bay; after all, it is acutely aware of the few wrong calls it made in the past.

A Tough Transition
The biggest advantage the new entrants had in 1993 was that legacy, indeed, was a burden. Flabby state-run banks had 95 per cent market share, but were not responsive to a fast changing India. The newbies’ clean slates, however, were soon filled with squiggles — they were manned by state-run bank staffers; it was not really fresh blood. Loans doled out in haste piled up as dud assets as the mid-1990s’ high interest rate regime started to bite. This time, too, things may not be very different. After all, there is no banking model in the world that is ‘new’ in the strict sense of the word. But, what’s unique about the current round of licences is that the new banks may mostly be converts from NBFCs, unlike in 1993.

Says G.S. Sundararajan, group director of Shriram Group: “The name of the game will be a demonstrated expertise in financial inclusion, trusted brand equity across the country and a healthy risk appetite. A huge untapped potential exists in the MSME (micro, small and medium enterprises) space in urban and semi-urban areas as well as in the retail space in
rural areas.”

B.R. Shetty, India chairman of Kochi-based UAE Exchange (one of the applicants), wants to build on the ‘bottom of the pyramid’ plot. “Our biggest strength is working closely with remitters who send money in the Rs 15,000-18,000 range.” He quotes from Census 2011 — only 59 per cent households availed of banking services. “It is due to our rural and low-income populace… financial illiteracy, lack of collateral and absence of verifiable credit history,” adds Shetty. A moot point then is if it is within a bank’s remit to set right a societal dirge.

Shinjini Kumar, executive director at PricewaterhouseCoopers (India), adds a reality check: “You were successful as an NBFC because the business model was different; but it does not automatically ensure success as bank.” So, the customer-friendliness of an NBFC will no longer be in play. It is one thing to service a trucker with a 180-day bad-loan norm and another when the limit is 90 days. The desire among NBFCs for a bank licence is also partly triggered by a report by Usha Thorat (former deputy governor of RBI), which may lead to a shakeout among NBFCs.

 So, it makes sense for an NBFC to become a bank as that will give it cheap access to current and savings accounts (Casa). But the twist in the tale is that as individual components, the growth of current and savings accounts at the systemic level grew by minus 1.8 per cent and 13.1 per cent in 2011-12 (from 12.3 per cent and 21.8 per cent in 2010-11). To the extent, the share of state-run banks in deposits is the highest at 55 per cent, it goes to prove that having a large number of branches does not mean an ever-growing Casa. In the case of new banks, Casa can be built up only by offering higher rates to wean depositors.

Even if an NBFC gets this far, it has to get its math right. The central bank has made it clear that an NBFC will have to convert into a bank right from day one — it has to set funds aside for reserves (cash reserve ratio, or CRR, of 4 per cent and statutory liquidity ratio, or SLR, of 23 per cent). That means, of every Rs 100 by way of deposits, Rs 27 will be locked away.

This is scary for NBFCs as their fund sources are high-cost fixed deposits or debentures (and, so, they perforce have to lend at rates higher than banks) compared to banks, which have access to cheap Casa. This is one of the reasons why Mahindra Finance dropped out of the licence race. “The regulations require that CRR and SLR norms be applicable from inception, even though building of Casa will take some time for newly converted banks. This anomaly will impose an undue penalty on large-asset-financing NBFCs,” says a Mahindra Finance spokesperson.

PwC’s Kumar, however, says it could still work if a new bank were to follow an NBFC’s asset profile of  “small ticket size, higher margin”. IndusInd Bank’s Sobti says, “It’s a no brainer. Even I can do it now. You cannot say you will turn into a bank and continue to lend as an NBFC. Get this clear: when you morph into a bank, you have come into a low-margin business. Why would anybody want to do it? I cannot understand.”

Apart from the steep reserve requirements, there is the rule that says 25 per cent of a new bank’s branches have to be in rural areas with a population under 10,000 and without existing banking services. It’s of no help when the central bank says an NBFC can convert all its branches into bank branches. A branch in a semi-urban or rural area costs Rs 40-45 lakh per annum. Ratnakar Bank pays about Rs 1.6 crore for a 2,000 sq. ft branch (zonal) in New Delhi’s Gopaldas Bhavan; a similar branch in Mumbai’s Parel will cost nearly Rs 2 crore.

The 25 per cent rural branch rule is to ensure that the country’s unbanked areas are penetrated. But if you were to take agri loans under the priority sector as a surrogate for financial inclusion, it gets worse. In its Report on the Trend and Progress of Banking in India (2011-12), RBI says that only one-fourth of agri credit reached small and marginal farmers. “Importantly, 13.6 per cent of it was absorbed by corporates, partnership firms and institutions engaged in agriculture.” Banks play safe and lend to the big fish in the priority pool. This tendency is  explained by the fact that agri loans accounted for 50 per cent of the dud loan pile in end-March 2012; what does not hit the banks is that the rest is also due to the Leviathans.

Worse, data on priority loans (the latest for the industry as on last reporting Friday of March 2012) shows 16 of 26 state-run banks failed to meet the target of 40 per cent. Fifteen state-run banks did not meet the sub-target for agriculture, and 11 for weaker sections. Among the private banks, six could not meet the priority target of 40 per cent; and 13 for the sub-target of agriculture. As for loans to MSMEs, the balance is tilted in favour of the larger borrowers. As on the last reporting Friday of March 2011 (latest consolidated data), only 21.1 per cent was disbursed to micro (manufacturing) enterprises with investment up to Rs 5 lakh and micro (service) enterprises (up to Rs 2 lakh) as against the prescribed target of 40 per cent.

India Inc And Banks
The new banks will have to deal with a bigger headache: they will be required to be capitalised at Rs 500 crore. The capital adequacy ratio is pegged at 9 per cent — a new bank can build a book of Rs 4,500 crore (nine times is the leverage), and then it has to bring in fresh funds. And Rs 4,500 crore is the kind of bulk a medium-sized bank puts on in a single quarter! “The minimum capital of Rs 500 crore is good for starters, but you need Rs 5,000-7,000 crore in the short term,” says Ahuja. Such numbers turn the idea of more banks to service the unbanked through inexpensive means on its head. “‘It is pure baloney to say new banks will or can do, or think of something that we can’t. The cost of regulation is high,” says Sobti.

By RBI estimates, state-run banks will need Rs 1.5 lakh crore in common equity to achieve full implementation of Basel-III norms by 2018, plus another Rs 2.75 lakh crore in non-equity capital. For big private banks, it will be Rs 25,000 crore and Rs 50,000 crore. The higher capital would mean inducing investors to accept a lower return on equity (RoE). The question is: will investors wait? “It takes 10 years to get an RoE of 10 per cent for any private bank. It’s better to put that kind of money in bank deposits rather than set up a bank,” says Ahuja.

Australia, Canada, Germany, France and the UK do not specifically bar industrial houses from setting up banks, but limit the voting rights and controlling positions a shareholder can obtain. The UK allows industrial groups in banking — Tesco Bank is an example. In the US, this is not allowed; and the regulatory framework is designed to protect a bank from risks posed by the activities or conditions of the parent and its non-bank arms, to maintain a Chinese wall between banking and commerce. But GM, GE, BMW, Volkswagen and Volvo own “industrial loan companies” to support their global operations.

It brings us to the question: what is in it for big desi corporate houses? Given that after a lock-in of five years, they will have to cut their stake to 15 per cent within 12 years, and that they cannot avail of credit from the bank. But Srinivasan believes a new bank that harnesses technology and understands rural India can deliver — in SMEs, agri credit and retail banking. He admires Wells Fargo for the kind of cross-selling it does. But few will admit that there are egos at play. The grapevine has it that many aspirants have already sounded out small banks for a merger!
Mint Road has pinned its hopes on ceteris paribus — a bank promoted by a large industrial group or an established NBFC will be able to foster financial inclusion. But its own discussion paper (dated 11 August 2010) had highlighted the pitfalls. A model tilting towards financial inclusion may not be able to provide commensurate returns to banks to enable them to compete with others; cross-subsidisation with other gains is not possible. It will create an uneven playing field vis-à-vis existing banks. And, in case a bank deviates from its proposed business model, particularly if its earnings are low enough to threaten its viability, there may not be any regulatory remedy. The thrust on financial inclusion will thus be lost in such cases. The Rolls Royce, the Bentley, and the BMW may move out of the garage. What about the bank?


(This story was published in BW | Businessworld Issue Dated 27-07-2013)