Setting the bar for new banks:: Business Line,

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The RBI, in its guidelines, has ensured that the core objective of improving financial inclusion is not compromised by the new entrants.

The banking sector has been in a consolidation phase over the last few years. This is evidenced by the fact that only two banks were issued licences in the last decade, while there have been around 19 bank mergers and acquisitions. New banks have not had it easy either since only seven of the 12 banks set up since 1993 are currently operational.

Given this backdrop, the Ministry of Finance's announcement of new bank licences in February 2010 came as a surprise. The Reserve Bank of India (RBI) has now gone ahead and prepared the draft guidelines for issuing bank licences. This time around, there is a significant dilution from the RBI's stubborn stance with respect to allowing big industrial houses to set up a bank. While preparing the guidelines, however, the central bank has managed to set the bar high so that only serious players can enter the system. It also made sure that the core objective of improving financial inclusion is not compromised by the new entrants.

However, this skews the cost-benefit equation of the new entrants towards the former (cost). We also expect non-banking finance companies (NBFC) to benefit more than un-related entrants.

DRAFT GUIDELINES

The RBI has made it clear that only private entities owned by resident Indians can own a bank. This rules out government-owned companies such as Power Finance Corporation and Rural Electrification Corporation. The companies that can spare cash to set up a bank would be big corporate houses such as such as the Tata, Birla, Bajaj, Mahindra, Larsen and Toubro and Reliance. The RBI intends to ring-fence the bank from the parent entity by setting up a non-operating holding company (NOHC) that will be governed by the RBI.

There are other quantitative and qualitative requirements that corporates have to adhere to beyond capital infusion. Diversified shareholding of corporates and more than 10 years of track record are also necessary.

The central bank may seek feedback from various regulators, investigation and enforcement agencies on applicants. Good corporate governance is the RBI's trump card which will allow it to ignore companies that have flouted rules historically.

The RBI has ruled out banking licences for groups with income or assets of more than 10 per cent of the total from real estate and/or capital market. This excludes capital market majors such as India Infoline Financial Services, Indiabulls group, Religare and Edelweiss from setting up a bank.

ISSUES WITH THE REGULATION 

The regulation stipulates that new banks should list two years from the date of receipt of licence. As the operation may commence two-three months after receipt of the licence, the bank may have very little operational history before listing. This will prevent it from demanding an attractive price in the offer. Also, post-listing, the bank will have an inflated capital which would prolong the improvement in profitability.

That the promoters have to bring down the proportion of ownership to 40 per cent by end of year two is also tricky. The banks can raise fresh equity from the capital market to meet this requirement, but that would bloat the capital unnecessarily. Alternately, they can divest stake from existing equity but this would mean no additional infusion of capital for another three years since the regulation stipulates so.

Weak equity markets can also derail such capital raising or divestment. The last time Yes Bank listed we were in a bull market which allowed it to demand a 2.25 times price-to-book valuation. It was the lone new private bank to list in that period. Prospective bank licences may crowd the primary market and capital raising might not be that easy.

Another drag on profitability is the requirement that 25 per cent of the total branches have to be set up in under-banked areas where cost of breaking-even for a branch may be high.

Since in the initial year of operations, access to low-cost deposits is low, higher cost of funds coupled with high wholesale borrowing, will impact the spreads and profitability adversely. For incumbent banks only a quarter of incremental branches have to set up in unbanked areas. This puts new banks in disadvantaged position.

New bank licencees are also required to adhere to 40 per cent priority lending sector norms from the outset. Also, they cannot use the NBFCs to meet most their priority sector lending targets post-RBI regulation.

The way out for new banks could be to look out for acquisition candidates immediately after getting a licence. They may, however, have to pay a premium for acquiring old private banks (which have been attractive acquisition candidates for long). This would lead mean sub-optimal allocation of capital. Additionally this wouldn't serve the Finance Minister's vision of having more banks.

THREAT TO EXISTING PLAYERS

Yes Bank and Kotak Mahindra Bank, the latest entrants, have garnered a market share in advance of 1.5 per cent over the last seven years. If one notices the market share patterns of banks, public sector banks have bigger market share in advances as compared to what they had six years ago. They had 71.4 per cent share of advances in June 2005 which currently is at 74.8 per cent. Private banks' share has remained unaltered in this period. This means that the new entrants dented old private banks' and foreign banks' share. It can, therefore, be surmised that the competition from new banks would hurt the newer players before posing a threat to incumbent players.

NBFCS BEST PLACED

As of March 2010, NBFCs assets were around 11 per cent of the total bank assets. So any transfer of assets from these companies to new banks would give them a head-start over other new entrants. The RBI has recently reduced the regulatory arbitrage for NBFCs through a series of regulations. These changes could provide the impetus to push some of them into converting into banks.

NBFCs have a choice to convert into a bank or transfer a part of their asset book to newly set up a bank. In both the cases, they are not allowed to duplicate lending done by newly set up bank. This augurs well for the NBFCs which have a rural presence as it will allow them to adhere to priority sector norms. Shriram Transport and Mahindra Finance stand to gain in this way as they have a strong rural presence.

Existing NBFCs that convert into banks have to stick to the norm of setting up branches in unbanked areas (with less than 9,900 population) for only the branches in Tier-1 and Tier-2 cities.

For branches in Tier-3 to 6 areas, these norms need not be applied. This places them at an advantage to other private banks that have to open a quarter of their branches in areas in unbanked areas.