Free branching tops banking reform plan

Written by Sunny Verma | New Delhi | Updated: Oct 27 2009, 07:35am hrs
Raghuram Rajan
The government is considering far-reaching reforms in the banking sector, including giving banks the freedom to open branches in Tier-3 and Tier-4 cities, and granting 15 new licences to smaller banks for the first time in almost 11 years.

Prime Minister Manmohan Singh is learnt to have discussed several reform measures with Reserve Bank of India governor D Subbarao in the second week of October. They also discussed the idea of giving foreign banks full national treatment by suggesting they incorporate in India as wholly owned subsidiaries.

The reforms are part of a report submitted last month to the PM by his economic advisor, Raghuram Rajan, who chaired the committee on financial sector reforms. Based on that report, the PMO has prepared a list of doable reforms. Rajan also attended Subbaraos meeting with the PM.

The RBI governor is understood to have agreed to the idea of free branching in Tier-3 and Tier-4 cities, instead of similar permission in unbanked areas that the central bank has been contemplating. The government has termed it a cautiously bold move. There is a possibility that RBI may permit free branching in semi-urban areas, said Corporation Bank CMD JM Garg.

The PMO has suggested that RBI refrain from attaching any conditions such as asking banks to open branches in unbanked areas for every branch opened elsewhere. Census 2001 defines a Class-3 city as one with a population of 20,000-50,000 and a Class-4 city as having 10,000-20,000. Cities with less than 50,000 people account for about 7-8% of India's total urban population, said Rajesh Shukla, chief statistician at National Council of Applied Economic Research.

The government has further suggested RBI contemplate giving 15 fresh small bank licences to reputable promoters that use core banking solutions. It said this could be started as a four-year experiment and further licenses should be approved only after reviewing the experience. Managements have to be run on professional lines for small banks or local area banks to be successful, said Garg.

However, the government said this is unlikely to raise any concerns over stability, as RBI would supervise the licences and operations of these banks. RBI has not given any small bank a licence since the then governor C Rangarajans term ended in December 1997.

With regard to foreign banks, the government has asked RBI to ascertain whether they can be required to be incorporated domestically. Foreign banks can be given full national treatmentat par with domestic banksif they incorporate domestically, it has suggested.

It further debated whether such banks could be given branching rights at par with Indian banks over a period of two years. However, this requires reciprocal treatment, especially for Indian banks expanding into the US and East Asian countries, including Singapore.

The government is also strongly pitching for expanding the banking correspondent model and mobile banking in its quest for financial inclusion. Cabinet secretary KM Chandrasekhar has called a high-level meeting of secretaries on Thursday to flesh out the mobile banking proposal.

Lastly, the government discussed making the priority sector loan portfolio of banks tradable. Currently, banks have to meet priority sector loan requirements based on actual loan sales. But the fresh proposal envisages permitting banks to sell their extra priority-sector credits to banks that require them. The government suggested RBI set up a committee to examine this.

The Economic Survey 2008-09 too has suggested this. Allow trading of directed credit obligations among banks and other financial institutions. This will allow and encourage the development of financial institutions that can specialise in and exploit economies of scale and scope in unbanked and low-banked areas and sectors, the survey argued.