Building a brave new world of banking

The recent press release by the Reserve Bank of India on its acceptance of 21 of the recommendations made by the internal working group, with minor modifications, is a welcome step towards the extant ownership guidelines and corporate structure for Indian private sector banks. The much-awaited decision on the conversion of non-banking financial companies or NBFCs into universal banks and allowing large corporate/ industrial houses to run banks may soon be addressed by the regulator as well.

Of course, for admitting large corporates/industrial houses, the Banking Regulation Act, 1949 needs amendments, and will have to go through the parliamentary process. In the case of well-run large NBFCs, with the exception of two or three of them, the rest, as the report suggests, are owned by corporate houses.

We also know that these NBFCs may not be per se interested in switching from one structure to another. They have shown no interest in the on-tap universal bank route, which was opened up much earlier. It is imperative that the regulator examines the areas of difficulty faced by these entities, and the likely benefits to the system and the stakeholders, including the shareholders of these entities. The last experiment of universal bank licences to two entities is yet to provide any conclusion. Likewise, the earlier attempt to broad-base private sector banking’s corporate structure by way of licensing differentiated banks has not provided healthy results. Companies under both the structures, the payments banking and small finance banking (SFB), are struggling.
 

In the case of payments banking, the pandemic has led to exponential growth in digital payments, yet there are only three active payments banks out of the 11 licensed and they too are yet to become stable. If some of the licensed payments banks now aspire to become SFBs, the attempt looks far from convincing as the SFB experiment itself is far from proven and established. From the licences offered to these banks, most were microfinance institutions and some were NBFCs. Unfortunately, both sets of entities seem to be struggling with the quality of their assets. The pandemic has made it more difficult for the SFBs to perform.

The differentiated banking model, therefore, has been far from convincing and may take more time to stabilise. The underlying factors also do not suggest any radical change unless the stakeholders are prepared, including the regulator, to take the structure back to the drawing board. In the case of payments banks, the conditions imposed could be re-examined. However, it should be noted that the universal banks, particularly the performing ones with large networks and technology adaptation, are unlikely to make the life of payments banks easy. The inability on the part of SFBs to build credit capability required for small loans and gradually withdraw from the business of tiny loans is a contributing factor. In this context, a single example of a multi-state urban co-operative bank transitioning into a small finance bank looks more convincing.

One gets the sense that somewhere the system’s noble objective of financial inclusion has not been addressed with proper structure-based answers. For those with irregular incomes needing financial support, small banks are far from a proper answer. The size of their coverage is insignificant compared to the extent of credit required by this segment. The total loan books of these SFBs is a drop in the ocean.

This brings us to the problem in hand. We create structures to respond to the system and to the growing needs of our economy. The banking system needs a substantial amount of capacity expansion, despite reduced intermediation share of banking gradually. Both savings and credit channelising of the banking system is gradually being replaced by NBFCs, capital markets and asset managers. The structural changes made by policymakers and the regulator are incremental in nature and wherever disruptive approaches are taken, such as differentiated banking, they have not had convincing outcomes.

When considering the remaining recommendations of the internal working group, there is a need to examine all the facets of the reforms to evolve a more lasting and convincing outcome. The question of capital requirement for Indian private sector banking articulated by the report should be addressed carefully. Is admission of corporate/industrial entities to banking a wise approach, particularly when most businesses owned and managed by industrial houses have cyclical challenges and they themselves may be over-leveraged or relying on the banking system? Is foreign capital the answer? The regulations should ensure long-term funds from overseas banks and other financial institutions with measures like capital lock-in periods, else investments will take flight during crisis periods.

The economy is growing and the need for credit will grow. Some of the initiatives in creating infrastructure finance institutions and asset reconstruction management are interesting but universal banking growth is certainly a moot question. When one examines the reforms made by the banking and financial regulators and policymakers in a few comparable jurisdictions, one major reason why they may be not as effective as desired is that both policymakers and regulators do not have commercial banking or industry personnel in their organisations. Thinkers and working members together may perhaps arrive at workable solutions.

The writer is managing partner, Ashvin Parekh Advisory Services LLP. Views are personal