This is not to say that such institutions do not have an important role to play in a modern and sophisticated financial system. Intimate knowledge of the risks intrinsic to particular regions or activities is also important in effective risk management. This is something that more focussed lenders can put to good use. But in terms of the basics, while this knowledge advantage may help such lenders differentiate between good and bad borrowers, it does not protect them from macro risks. An entire industry could be impacted by a new technology or a regulatory intervention. A region's economy could be adversely affected by drought or natural disaster. Such a risk profile is hardly recommended for potential depositors, who are not covered by deposit insurance, which, in any case, could be quite expensive for such institutions given their risk profile. Under these circumstances, the most effective way to take advantage of the knowledge factor is to restrict their access to wholesale funds - borrowing from well-diversified banks or other institutions, which have different risk appetites. This is what the non-banking financial sector has done in India and other countries and, clearly, some of these institutions have done very well with their focus strategies.
Of course, it doesn't always work. Memories of the mortgage companies in the United States, which passed on the risks of their portfolios through complex structured securities, are still vivid. It is generally perceived that these arrangements were an important transmission mechanism for the financial crisis. But lessons have undoubtedly been learnt and a two-tier structure, with conventional commercial banks exclusively taking retail deposits and the more specialised institutions in turn borrowing money from them, is perfectly feasible under an encompassing and internally consistent regulatory framework. In fact, this kind of arrangement may be far more effective in achieving the very goals that are being set for the commercial banking system - financial inclusion through widening geographic and sectoral exposures. Microfinance institutions, for example, may turn out to be a far more effective last-mile solution to the inclusion challenge than the typical commercial bank branch. In this context, the issuance of new bank licences is an entirely legitimate way of expanding the capacity of one of the two tiers in this framework. It will increase competitive pressure, which is all to the good. But this needs to be complemented with a compatible strategy for the entire range of institutions that comprise the second tier.