Beginning with the nationalisation of banks in 1969, the banking system in India has undergone several game changing interventions. Initiation of bank reforms based on the Narasimham Committee-I (1991) opened up the banking sector to private players, which heralded technology-led virtual anywhere, anytime banking services. Reforms based on internationally accepted prudential standards improved the operational efficiency and competitiveness of banks.
The Reserve Bank of India (RBI) constituted a committee headed by Dr Nachiket Mor in 2013 to recommend innovative solutions to accelerate financial inclusion in a sustainable and cost-effective way. One key recommendation in its report, in 2014, was to set up differentiated banks – Small Finance Banks (SFBs) and Payments Banks (PBs) to cater to the lower-income groups and small businesses. The strength of banks reached 143 by June 2020, with 10 SFBs, 6 PBs, and 43 Regional Rural Banks (RRBs). Total deposits of the banking system stood at Rs 144 lakh crore and total credit at Rs 104 lakh crore as on November 6, 2020.
In this evolving banking system, the report of the Internal Working Group (IWG) set up to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks is well packed with a set of next-generation bank reforms. The proposed measures can add to the strength of the banking system that can sub-serve the credit-starved entrepreneurs who have skills but no financial resources to fund their businesses.
Looking at the strategic role of banks in harnessing entrepreneurial potentiality, the present size and activity of banks are not adequate to tap the full potential of the economy. Moreover, the gaps in the banking system have become more obvious in the Covid-induced crisis. Banks had multiple challenges – rising asset quality woes, falling capital adequacy levels and rising expectation from banks to route the stimulus packages. Being key financial intermediaries, most of the relief measures provided by the government are routed through the banking system.
Even after the RBI opened floodgates of liquidity, banks were unable to adequately cope with the situation — large scale restructuring of loans after the end of the moratorium of six months to provide more time to borrowers to repay and at the same time providing them fresh loans to fund revival. The basic prudential principle of banking does not permit fresh loans to the borrowers on the brink of default. The shrinking capital adequacy ratio has also been a stumbling block.
It is not a short-term measure to open up banking system to strong non-banking financial companies (NBFCs). But from the long term perspective, the policy stance of IWG to open up opportunities to large NBFCs owned by the corporate sectors/private entrepreneurs with asset size of Rs 50,000 crore and above to convert into banks is a well-thought move to increase the size and presence of the banking system.
With over 10-year operations, NBFCs have the experience to add value by entering into retail banking and lending effectively to micro small and medium industries (MSMEs). Their synergy of speed in lending with shorter turnaround time, simplified procedures and strong due diligence verification can add value to the banking system. They have persuasive recovery approaches that can resolve asset quality qualms.
The IWG proposes that PBs with three years of operational experience can also convert into SFBs. SFBs and PBs will have to be listed within six years from the date of reaching net worth equivalent to entry-level requirements prescribed for universal banks – Rs 1,000 crore or 10 years from the date of commencement whichever is earlier. Promoter shareholding is raised from 15% to 26% while non-promoter shareholding – voting equity – is capped at 15%. It provides the right balance to the stakeholders and makes entry into banking an attractive value proposition for NBFCs. This is a step ahead when RBI had put in place a framework for co-origination of loans by banks and NBFCs in 2018.
Minimum entry-level capital for universal banks is now pegged at Rs 1,000 crore and Rs 300 crore for SFBs. However, it remains the same at Rs 100 crore for PBs. Conflict of interest is tackled through proposing a non-operative finance holding company (NOFHC) structure to separate ownership and management control. This is in line with the spirit of recommendations of Dr PJ Nayak Committee in his ‘Report of The Committee to Review Governance of Boards of Banks in India’ even for public sector banks (PSBs) to separate government ownership and grant autonomy in their functioning. The transition of the ownership structure of existing private banks licensed before 2013 is also clearly outlined making the road map clear.
Missing Credit Growth
Much of the developments so far have been on the liability side of the balance sheet of the banks. Integrated technology offerings have introduced more deposit products, increased remittances, ancillary services with round the clock access, chatbots for interactive resolution of customer queries but not much has been done to improve credit delivery. The actual growth of the economy comes from funding the enterprises.
The credit to GDP ratio is still at a staggering low, close to 50% as against China’s 165%, Japan – 174%, UK – 133% and US – 192%. Moreover, according to the financial inclusion index of World Bank – Findex 2017, 80% of people above the age of 15 years have a bank account in India. However, expanded banking is yet to be explored.
The use of such customer connect is commonly found confined to direct benefit transfer (DBT) of subsidies and other government reliefs that increased remittances traffic through digital mode. The new banking outlets with their past experience of lending to local entrepreneurs will be able to make a difference to eventually expand credit with greater penetration in the hinterland.
The present move to expand the scope for new entrants into the banking sector from NBFCs should be able to bring much relief to the aspiring community of budding entrepreneurs. It will take time for the proposed framework of IWG to work its way to bring the desired transformation in the banking sector, but a constructive road map has been well laid.
(The author is Adjunct Professor, Institute of Insurance and Risk Management [IIRM]. The views are his own)
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