The future looks bright but we need a steadfast RBI

April 16, 2014

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The future looks bright but we need a steadfast RBI

New bank licenses

On the topical issue of new bank licenses, Governor Rajan kept his word and the day after the Bi- monthly Monetary Policy Statement released on April 1, 2014, RBI announced the issue of two in principle licences to IDFC and Bandhan. It has taken a full four years, after the former Finance Minister Pranab Mukherjee’s announcement of the government’s intention to grant new licenses, for the RBI to grant licenses.

Clearly this is far too long - to use up four out the twenty two years post liberalisation in granting two licences!  However, Rajan and the RBI need to be commended for their resolve in going through with the licensing process and issuing two licenses despite pressure to halt the process with elections and a possible change in government in June.

Also, on the positive side, Rajan has promised (reference his remarks in post-statement conference call) on-tap licensing and differentiated licenses. It appears that Rajan is in favour of first opening the differentiated licenses window soon, and then in two-three years (“every few years”) the on-tap licensing window for full licenses (reference his remarks in post-statement conference call to press).  This means that those who did not get a full license in this round can go in for a differentiated license (I am assuming they need to be strong in some aspect of banking – example, lending or payments) or can wait for two –three years and try again for a full license.

Of the applicants for the new bank license, Muthoot Finance is a specialist at lending against gold. So, does this mean RBI is now in favour of granting a differentiated license to a few of the gold loan companies?

A key factor generally in the award of licenses is the reputation for good business practices of the applicant. Gold loan companies will need to first and foremost pass this key test to get a differentiated license.

Will IDFC and Bandhan move away from their strengths?

IDFC and Bandhan are both specialists – the former in infrastructure and the latter in microfinance. Both have made a solid contribution to areas that are of secondary interest to mainstream private sector banks.

As a bank, IDFC will now have access to the public’s cash, savings bank, and deposit accounts. This would, in the normal course, become the predominant source of funding for IDFC. If it continues to be an infrastructure lender or in fact goes even stronger into the infrastructure space, having access to far larger funds, then the mismatch between its assets and liabilities will increase because infrastructure lending typically is of longer maturities than industrial loans. This makes IDFC a riskier bank and a headache for the RBI.

This explains why the former project and development finance institutions such as ICICI and IDBI have actually moved away from their original mandate and become plain vanilla commercial banks, albeit far more profitable – at least in the case of ICICI, after getting a bank license.

It will be interesting to see how IDFC transforms itself after it becomes operational as a bank. There is an urgent need for more funding in infrastructure. Can IDFC, with the support of the RBI, come up with an innovative and solid business model to grow infrastructure funding? Surely, they should try. And this would bring more new entrants – both banks and NBFCs - into infrastructure lending. Otherwise, IDFC would be a case of good pedigree and clever (or fortuitous) differentiation to get a bank license, so far as infrastructure is concerned!

Bandhan’s case looks more positive. Here, there is no such mismatch between assets and liabilities. In fact, Bandhan gets the full arsenal of products and tools to become a full service bank to the financially excluded – cash, deposits, savings accounts, money transfer, distribution of other financial products and banking technology. 

Bandhan will need to re-price its loans once it becomes a bank. Will the asset and liability mix of Bandhan make it less profitable? Will this push its strategy away from the financially excluded to mainstream banking? Bandhan has another challenge: governance and operational practices of a bank are very different from the somewhat semi-formal world (to a banker) of microfinance, and Bandhan may stumble in crossing these hurdles.

I do hope Bandhan succeeds with a continued focus on the financially excluded. This would be great for the success of financial inclusion – both NBFCs and banks will make a further move into the sector, some financial innovation will take place and this should lead to better services for all.

Were there other deserving candidates?

Both IDFC and Bandhan are deserving candidates. RBI has chosen to play it safe, especially with the uncertainty associated with a new government in power in a short while. RBI was wise to keep industrial houses out of the reckoning this time; in any case some in the RBI have had privately (Rajan, prior to becoming Governor, was brave to have reportedly quoted in the press that he was not in favour of industrial houses getting a bank license) reservations, and rightly so, about awarding a license to a business house.

But could not the RBI have considered a few more applicants with a sole/predominant focus on financial services? Here the RBI has again erred on the side of caution. Note this time, as I understand from a press report in Live Mint, the Advisory Committee (Jalan committee) did not make any recommendations out of the list of applicants, but instead chose to do a SWOT analysis of the applicants.

And what is sanctity of the number two? Why not four licenses in a country where a large part of the population does not have a bank account or where most SMEs find it very difficult to get a bank loan?

The problem is that there is not enough transparency in the licensing process. What does a deserving rejected applicant now do? Wait for 2-3 years for on-tap licensing? And who knows what the key driver for giving a license in 2016 will be?

Should the rejected applicant go in for a differentiated license? Will differentiated licenses be issued only to those who have already shown a successful track record as a specialist? If that is so, then a few of the specialist lenders in the list of twenty five applicants have a good chance.

There is no specialist payment institution among the rejected applicants. So, this is going to be an area of opportunity in the coming years.

Both differentiated licenses and on tap –licensing have been mooted in the past. But it is Rajan’s conviction that has pushed this through at the RBI. On balance, we appear to be moving into an era of more banking licenses, assuming the RBI steadfastly continues with this policy, during Rajan’s tenure and later. This is a positive development.

Bank mergers

Rajan has an open mind on bank mergers. RBI will not push for it, but if the industry takes the initiative then the RBI will be supportive of it (I guess on a case by case basis). On the issue of whether foreign banks will be allowed to take over Indian banks, Rajan wants foreign banks to first move their current operations into WOS (wholly owned subsidiaries) and then he seems to be prepared to consider their takeover of Indian banks (reference Rajan’s remarks in post-statement conference call with the press).

NBFC merging with a bank

Today a few NBFCs are larger and better run than certain banks. One question then arises: can a NBFC that did not get a license or did not apply in this round now approach the RBI to merge with a bank? The RBI should keep on open mind on this option also.