New entrants should consider buying an existing private bank that needs Assistance; This will mean ready infrastructure for the entrant and easy exit for a weak player
The last pertains to allowing NBFCs to convert to banks provided their asset size is above Rs 50,000 crore. Representative Image
By Madan Sabnavis
RBI’s recently released norms on ownership of banks raise a fundamental question: Do we need more banks in the country? The move towards the consolidation of public sector banks and the problems that have enveloped private banks such as Yes Bank and LVB should give reason for pause. Aren’t we looking at having big banks that have a strong capital base and can compete globally? Aren’t we concerned about the possible governance lapses in the conduct of some banks that has caused considerable upheaval at different points of time?
While having more players in any field is looked upon positively, the banking story is different. However, critics presented a counter view a few years ago when the on-tap licensing policy was announced. We have seen several private banks crop up since 1993; some have closed down, while others have merged for various reasons. It was either a case of viability or governance or simply a lack of long-term commitment. Exits were easy as the promoters left with a profit on most occasions. The so-called new private banks, which are over 25-years old now, are few in number, and allowing more players may not resonate well. Even among the last two new banks which were recognised, one has been merged with an NBFC. Quite clearly, it would be necessary to exercise caution here.
Some of RBI’s proposals merit comment. The first pertains to allowing corporates, albeit with certain conditions. In fact, even in the earlier round, this was allowed. There is, though, a strong reason for not allowing such entities as they have a vested interest. Therefore, screening of applications requires a lot of due diligence.
Corporates are basically borrowers from banks. They use funds to grow business. While the preconditions in terms of equity and dilution will be met subsequently, the challenge is to ensure that funds are not diverted to concerns which they have an interest in. In almost all cases of misgovernance that have come to light in the Indian banking space—and even globally—such diversion has been witnessed and discovered several years after the bubble burst. RBI will have to pay special attention to such banks. Large corporates operate hundreds of subsidiaries which are linked to the parent entity without the knowledge of the regulators.
Three ideas come to mind. First, once these are permitted to operate a bank, RBI needs to have some compliances/ disclosures in place to ensure that such developments do not take place. Second, some thought has to be given to the economic phenomenon of ‘unfair competition’, where entities dominant in the real sector can build the final link to the financial sector and create large monopolistic centres. While this concern may look exaggerated, such waves build over time, and as the new entity starts getting into M&As, at a later stage, it can carve out a dominant space in the banking sector. The Competition Commission could be consulted on this.
Three, when setting the criteria for considering applications, the last 10 years’ history has to be examined to show that these potential promoters have never had an NPA, or had involvement in any economic irregularity and so on. An objective scorecard should be used in such cases.
Another matter relates to the issue of mandatory listing. All existing banks are indeed listed, and it would be hard to ask them to act otherwise. Banks have to be seen as financial infrastructure, and ideally, should not be commanding such high stock valuation. But, across the world, banks are listed, and hence, it would be out of place not to allow listing in India. However, our history shows that promoters with little long-term commitment can start a bank, have it listed and as they unwind their stake, exit and make money in this process. It is the king of PE activity. Do we want such a route to exist? In fact, the norms that require banks to get listed within six years allow the promoter to make a profit as her stake is brought down to 26%.
The issue with listing is that, once complete, banks work on a quarter-to-quarter basis and have to deliver profit progressively to shareholders. This is one reason why they take on a higher risk to build size and income, which could come back to haunt them as NPAs. While it may be argued that the regulator should not be worried about the model as long as the banks are compliant, the cumulative write-offs in the system have literally eroded the value of the deposit holder’s money. As banks provide for NPAs, they are forced to keep deposit rates low and lending rates high, which is not what banking is about. This is admittedly a sticky issue as norms for dilution of stake and listing already exist, and it is hard to roll back now.
The last pertains to allowing NBFCs to convert to banks provided their asset size is above Rs 50,000 crore. Here, if one excludes the HFCs and PSUs in the finance space, not more than four or five would qualify. This is definitely a good opening as these entities have vindicated their commitment, especially for last-mile connectivity. But here too, RBI can put in conditions. The last decade’s performance record would be a useful start. Further, RBI can look at the number of deviations from regulatory compliances for these NBFCs and can use discretion on whether these lapses are of a serious nature or have been repeated.
Urban cooperative banks and payments banks have been allowed to apply to get converted to small finance banks. This is not surprising as there was always a question mark on the sustainability of payments banks’ and the cooperative banks’ models, which have not quite worked well. It would be interesting to see as to how many banks would opt for conversion. The small finance banks are niche players and have to, by definition, do only priority sector lending. Having more of such banks operating in the countryside will help in financial inclusion. But, having cooperative banks that have not been successful in this space and applying for conversion requires strict due diligence.
Is it possible to think differently, in light of the arguments forwarded here? Quite in the manner how RBI has worked to find suitors for private banks that have failed, is it possible for all the new entrants to actually first consider buying up an existing private bank that requires assistance or a UCB or a payments bank. This can be a way of solving the two issues of support for a weak bank and opening the doors to new players. This can be done for both new commercial (universal) banks and small finance banks. There will be physical infrastructure available for the entrant and an exit route for the weak bank. In fact, even the qualifying NBFCs should be made to consider this offer.
At present, there are several banks that are struggling to stay afloat but have basic infrastructure. A new bank will have to begin at the baseline. To align the two, RBI should actively consider this option which will bring in economies in operation. But, for sure, it would lead to questioning the necessity of having more players, which may not be there 15 years down the line, and then struggling to keep the weak banks afloat.
Author is Chief economist, CARE Ratings and author of: Hits and Misses – The Indian Banking story (Sage) (to be released in December). Views are personal