But the idea of auctioning licences isn't appealing, and the governor of the Reserve Bank of India (RBI) rightly rejected the suggestion. We must understand that the key driver for opening up the sector to new players is to encourage new ideas, innovations and capital to enhance financial inclusion or the number of people that have access to banking services and financial products. Today, only a little over half the country's population is covered by existing banks and a much lower slice has access to most of the products, particularly credit and remittances. We have a dual banking need. On the one hand, we need big banks that can service large and growing Indian companies that are expanding globally; on the other, we need small, specialised banks with expertise to service domestic small and medium enterprises and rural requirements.
If licences are auctioned, the auction premium will be a cost deterrent for new players to achieve inclusion. It will also be a huge disadvantage to the new banks vis-à-vis incumbents and can drive the former to riskier activities to make up for the return on auction. The worst possible outcome derailing the initiative would be allegations of malpractice and the sector getting embroiled in a legal tangle just as the telecom sector now finds itself. New banks are not scarce natural resources like minerals that face the imminent risk of depletion nor are they like telecom spectrum, which can be auctioned to raise resources.
But we also believe that it is not necessary to ration or limit the number of bank licences awarded either. While there is no official directive on the exact number of bank licences to be awarded, if the market buzz is to be believed, it would be restricted to five or eight only. Limited entry to aspirants gives incumbent players an environment protected from new competitors. In a growing market, this leads to protected margins and adequate business and, therefore, little incentive for innovation and experimenting with new ideas.
Financial inclusion in India is perceived as an obligation. Most public sector banks as well as private sectors banks budget certain losses to meet regulatory norms; needless to say, these banks make up more than that in their business in supposedly over-banked segments. Against the principle of any economic theory and unlike any other industry, banks are happier servicing over-banked regions and over-served customers. This is because the regulatory framework protects existing players from new competitors and, therefore, their margins.
For a long time, in sectors like cement and steel, among others, Indian policy makers regulated new players, capacity and pricing. These sectors were opened up in 1991 and now nobody complains about profiteering, high prices and low availability nor does anybody have to force these producers to go to rural markets. There are several examples of banks in Mexico, South Africa, Brazil, Indonesia and Kenya that have successfully used low-cost, technology-driven models to expand profitably in unbanked rural areas of their respective countries.
The key challenges are effective regulation of the new banks against risks of failure, ensuring safety of deposit holders' money, preventing concentration of power as well as deviation from the larger objective of driving financial inclusion. The RBI has an impeccable track record and unassailable credentials in regulating the banking sector. The process of licensing and examining "fit and proper" cases is fairly robust. Given this situation, where is the need for limiting the number for new bank aspirants?
There is no doubt that banks have to be licensed, regulated and monitored for safety of public funds. A stricter entry criterion makes perfect sense, so does encouraging as many new "fit and sound" players as possible. The RBI's need for resources and managerial bandwidth to examine new applications and monitor a large number of players should not be a deterrent for the larger cause of the economy. If the US can regulate and cover by deposit insurance more than 7,000 banks, India can surely manage at least a few hundreds.
In the ultimate analysis, the survival of the fittest theory will apply irrespective of the number of new banks joining the fray. This widening of healthy competition in the banking sector will provide an uninterrupted flow of new ideas and innovations. It will ensure adequate blood supply for the economic arteries of the country to truly enable financial inclusion of the Indian masses and bring about phenomenal growth for our economy.
The author is Chairman, India Infoline Group