Only a free market fanatic would abolish the licensing system for opening bank branches. One however, has to look at it from two angles: the domestic impact, and the international equation. Most businessmen are driven by short-run profit opportunities. This compels many of them to compete for the most fertile land. They find no thrill in converting infertile to fertile or looking beyond the boundary.
In a completely licence-free environment, there would, therefore, be a rush to open branches in the most profitable areas, neglecting backward areas. There would be uneven growth with high-density metro and low-density rural networks. The latter could become a bottleneck for the growth of the former in the long run. Also, larger banks could turf out smaller ones creating a monopolistic market.
There is not much of a problem in over supply of branches in urban or metro areas. As long as a bank is viable, branch economics should not bother depositors. Banks may close these branches if they are not profitable. And because of a high penetration rate of bank branches, consumers might not suffer in the short run. But this may not be the case in the case of a monopolistic situation.
This, however, is not true for rural and backward areas, where there is much less density of bank branches; not every village has a bank branch and a majority of people are financially excluded. Banks do not have much inclination to go to villages voluntarily. After the commencement of financial sector reform, when banks were given a bit of freedom, the number of rural branches declined substantially, although the total number of branches increased; the share of rural deposits and credit in the total also declined. If anything, branch opening should be freed in under banked areas.
That doesnt mean each village must have a bank branch. But every villager must have access to formal financial services at their village. Micro-finance services can be provided efficiently in a village without opening a branch. Since banks do not generally understand the benefit of micro-financial services in the macroeconomic context, they need to be guided. Rural masses are expected to provide an enviable market for industrial growth. By providing appropriate micro-finance services, including credit-plus, migration to urban areas can be checked. This will ease the pressure on government.
Lastly, and most importantly, a healthy economic condition leads to a good social environment free of unrest, which can speed up the development process. The spread of Naxalism is basically an economic issue. Branch expansion, therefore, cannot be left to banks alone. Banks need to be accountable to society as well as the market. As far as possible, the objective of financial inclusion should be achieved through appropriate incentives.
However, the number of branches or accounts should not be the only criteria. Area-wise per capita deposits, credit, and other micro-finance services for the poor may be incorporated in a scoring model to determine the incentive level: (i) additional branches at desired location, (ii) tax benefits, or (iii) any other benefit; and the disincentive level: (i) penalty for not achieving the minimum score, (ii) withdrawal of incentives, etc. The second aspect of branch opening is with regard to international equations. For every branch of a foreign bank opened locally, there must be commensurate branch expansion overseas. There cannot be two different sets of rules in two different countries.
Branch expansion needs to be closely monitored by the central bank. Whereas both domestic and foreign banks are to be monitored for their contribution to the development process, foreign banks need to influence their own governments to allow a proportionate scope and space for Indian bank branches in their countries.
The writer is a professor at National Institute of Bank Management, Pune