Introduction
Banking nationalization took place in 1969 and in 1980 and since then banking sector was dominated by the public sector. Over a period of time, public sector dominance was seen to be acting against public interests in terms of limited technology usage, lack of risks or proactive measures taken, and excessive control by the government and bureaucracy. When the economy was in knee deep crisis in 1991, along with other sectors of economy, it was decided that the Banking sector would also be revamped to give space for new private players to operate and function based on the guidelines the RBI would then define.
In order to strengthen capital base, aim for reduction of Non Performing Assets and reducing the cost of operating a branch, the process of giving license to private banks was resorted to. The first time RBI came up with a definitive structure or guidelines for private players to function was in 1991(‘1993 Guidelines’) as a result of which 10 licenses were issued the second set of guidelines was in 2001(‘2001 Guidelines’) as a result of which 2 licenses were issued; both these guidelines together are referred to as ‘Previous Reform Guidelines’. This did have a positive effect on the economy by improving the overall efficiency in terms of improved customer service, improved technology, improved productivity and improved competence to deal with external competition.
In order to revisit the positive changes that took place before due to issuance of private license, the RBI introduced the “Guidelines on Licensing of New Banks in the Private Sector” for the third time after a detailed process which included various levels of discussions, invitation of comments revisions and finally the anticipated release. This article briefly discusses the regulations, impact on the banking sector and also comparing the said reforms with the Previous Reform Guidelines.
Overview of Regulatory Framework
The guidelines are briefly summarized as follows:
a) Eligible Promoters
Those Entities/groups which are either owned & controlled by residents or in the public sectors will be allowed to promote a bank through a wholly-owned Non-operative Financial Holding Company (NOFHC).
Promoters of an existing NBFC can also promote a bank by transferring the operations (partly or wholly) to the New Bank provided that such activity is permissible to be undertaken by the bank; or by converting the NBFC into the bank when the minimum net worth of the NBFC is INR 5 Billion and all activities of NBFC can be undertaken by the Bank; or the NBFC can divest those activities not permitted to be carried out by a bank. In all the cases the NBFCs are required to follow the Guidelines in its entirety.
Previous Reform Guidelines:
No requirement for setting up a NOFHC or any such corporate entity to operate the bank. Further involvement of large industrial groups in banking was discouraged. However, the 2001 Guidelines permitted individual companies to be directly or indirectly connected with large industrial houses to participate in equity of new private sector bank to a maximum limit of 10%. The 2001 Guidelines did permit NBFC could convert to a private bank upon fulfillment of certain specific criteria.
b) Fit and Proper Criteria
The Promoters should satisfy the ‘fit and proper’ criteria which is determined based on the parameters of sound credentials, integrity, successful track record and their existing business being aligned to an approved and sound banking model. RBI may also assess the aforementioned criteria on basis of reports provided from other regulators, enforcement and investigation agencies.
Previous Reform Guidelines:
They did not provide for such criteria explicitly however, RBI had the power to grant licenses based on merits of each case.
c) Corporate structure of the NOFHC
The NOFHC wholly owned by the Promoter/Promoter Group, shall essentially follow the corporate structure as provided:
a) No individual promoter (along with his relatives or with the entities they hold not less than 50% of the voting equity shares) in the Promoter Group shall hold voting equity shares not exceeding 10% of total voting equity shares of NOHFC.
b) Give voting equity shares of not exceeding 10% of the total voting equity shares of the NOHC holding the bank as well as the other financial services entities of the group, shall be wholly owned by the promoter/ promoter group. Stringent regulations are set to ensure that the bank and the financial services of the group are not affected by the other commercial activities of the group.
c) Those companies where public holds more than 51% of the voting equity shares, which forms a part of the Promoter group shall necessarily hold more 51% of the total voting equity shares of the NOFHC.
d) NOFHC would not be allowed to hold any financial service entity that a bank would otherwise is not permitted to undertake, for example activities such as insurance, mutual funds, stock broking etc., which requires a SPV/JV to be incorporated will be carried out through separate such entities under NOFHC
e) NOFHC except otherwise legally required or permitted by RBI, is not permitted to set up any new financial service entity for 3 years from date of commencement of business
f) Transferability of shares of NOFHC shall not be permissible to any entity outside the Promoter group. Any change in shareholding which results in a shareholder with more than 5% of voting equity capital of the NOFHC requires prior approval of RBI.
Previous Reform Guidelines:
Neither of the Previous Reform Guidelines provided for a defined corporate structure to operate a private bank. Further there was restriction on the Bank for setting up a subsidiary or mutual fund for at least three years from the date of commencement of business.
d) Minimum voting equity capital requirements (banks and shareholders)
The initial minimum paid up voting equity capital of the Bank shall be INR 5 Billion of which the NOFHC shall hold a minimum of 40% of the paid up voting equity capital subject to a lock in period of 5 years, this proportion is mandated to be maintained irrespective of bank raising further voting equity capital for the first five years form the date of commencement. If NOFHC holding is more than 40% it shall be brought down to 40% within three years form the date of commencement of business of the bank. The aforementioned NOFHC holding has to brought down to 20% within a period of 10 years and 15% within a period of 12 years. Further the bank shall get its shares listed on the stock exchanges within three years of the commencement of business by the bank.
Previous Reform Guidelines:
The 1993 Guidelines required a minimum paid up capital of INR 1 Billion and the 2001 Guidelines required a minimum paid up capital of INR 2 Billion which was to be increased to INR 3 Billion within 3 years of commencement of business.
Further the 1993 Guidelines did not provide for a fixed Promoters contribution, it was to be decided by the RBI on case to case basis, the 2001 reforms however mandated a 40% promoters’ contribution at any point of time.
e) Regulatory Frame work
NOFHCs will be governed by the provisions of the Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, Foreign Exchange Management Act, 1999, Payment and Settlement Systems Act, 2007 and other relevant statutes, directives, prudential regulations and other guidelines/instructions issued by RBI and SEBI.
Previous Reform Guidelines:
There has been almost no change in the regulatory framework except for new amendments, notifications and statutes which were enacted after 2001.
f) Foreign share holding
Non-resident shareholding in banks will be permitted upto 49% and no non-resident shareholder, directly or indirectly can hold more than 5% of the paid up voting equity capital of the bank for upto 5 years from the date commencement of business of the bank. After the expiry of the said 5 years, the aggregate foreign shareholding shall be as per the extant FDI policy.
Previous Reform Guidelines:
There has been no mention of FDI in banking sector in the 1993 Guidelines. However 2001 Reforms did provide for controlled NRI investments.
g) Corporate governance
The RBI Guidelines for Licensing have been formulated keeping in mind the interests of the public at large addressing, inter alia, restrictions on a director in one NOFHC from being a director in any other NOFHC, directors qualification specifications, independent directors etc.
Previous Reform Guidelines:
Corporate Governance was a term not specifically defined in the Previous Reform Guidelines, these were however covered within the scope of these guidelines in a generalist fashion. The 1993 Guidelines mandated that the bank would not be allowed to have a director, any person who is director of any other banking company or companies, which among themselves are entitled to exercise voting rights in excess of twenty per cent of the total voting rights of all the shareholders of the banking company, as laid down in the Banking Regulation Act, 1949. The 2001 Guidelines required the Bank to maintain an arms length relationship with business entities in the promoter group and the individual company/ies investing upto 10% of the equity.
h) Business plan
The applicants are expected to propose a viable and realistic business plan on how they propose to achieve financial inclusion.
Previous Reform Guidelines:
There was no Business Plan defined. However the permission to obtain a license was after RBI’s satisfaction of the case. 2001 Guidelines however mentioned that the preference would be given to the promoters with expertise in finance and bank establishment specializing in financing of rural and agro based industries.
i) Other conditions for the bank
Other conditions stipulated for the bank by RBI include socio welfare measures such as 25% of the branches to be in un-banked rural areas, the bank should comply with priority sector lending targets and sub sector targets from time to time. Previous Reform Guidelines did stipulate for compliance with priority sector lending targets however it did not provide for a compulsory braches establishment in unbanked rural areas.
Analysis
Many provisions including the requirement for the establishment of NOFHC, providing for the fit and proper criteria, facilitating industrial and business houses to participate etc. were not present in previous reform guidelines. These measures can certainly be seen as a welcome change to ensure adequate checks and balances against possible abuse of position by the Bank.
The application from the interested parties received till 1st July 2013 will be first screened by RBI, thereafter referred to a High Level Advisory Committee, the constitution of which hasn’t been announced. The Committee recommended Parties would be submitted to the RBI, who will then give an in principle approval. The names of all the applicants for the license will be documented in the website to ensure transparency. Though there is no official mention of the number of licenses RBI plans to issue, going by the previous trend, it is unlikely to be a large number.
Further in my view, the economy of India was in a much stronger to take risks as against the situation in 1993. During 1993 guidelines period, the guidelines were probably a necessity, to pull India from succumbing into foreign debt, dwindling resources and other evils that loomed in 1990s. Today it is more inclined towards economic growth, to ensure that the capital base is strengthened, to get at par with its international counterparts and to ensure effective corporate governance and ensuring a greater percentage of Indian population having access to such banking facilities.
Conclusion
The last two times (1993 and 2001) where such licenses to private sectors were introduced the total number of licenses issued was 10 and 2 respectively. The implementation of the privatization reforms in the banking sector has been slow and gradual. Further the entry of foreign players in this sector has ensured the entry of international trade and technology practices to permeate into the Indian markets. The international banking practices certainly point towards privatization.
There would certainly be doubts about pre-emption of credit by including business and industrial houses in the Banking domain. But it can also been seen that the 2013 Regulations are much stronger and well structured in comparison with the Previous Regulatory Guidelines. This coupled with the overall improved regulatory framework associated with banking is unlikely to facilitate an abuse of power by Industrial/business houses. Further the Banking Laws (Amendment) Bill, 2011, which is currently in the pipeline, intends to strengthen the regulatory powers of RBI in order to further develop the banking sector in India. A cumulative effect of a well structured set up, a stringent regulatory mechanism and planned policy making can ensure a positive impact of this privatization measure to be seen by large number of masses.
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