Financial Inclusion & Draft Guidelines

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1 Equitas response to RBI s draft banking license We welcome RBI s efforts in approaching the new banking licenses with a comprehensive long-term point of view. The recently released Draft Guidelines quoted the Finance Minister s announcement in his budget speech for It seems appropriate to begin there. Shri Pranab Mukherjee had said: The Indian banking system has emerged unscathed from the crisis. We need to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. Besides, there is a need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable Members that the RBI is considering giving some additional banking licences to private sector players. Non Banking Financial Companies could also be considered, if they meet the RBI s eligibility criteria. It would seem the mandate given by the Minister is to meet the following objectives: 1. Ensure growth in size & sophistication of India s banking system to enable it to support India s future economic needs 2. Expand access of banking services (presumably to cover those who either have no access or limited access to formal banking services) Since the release of draft guidelines by RBI, there has been considerable media interest/discussion on which corporate institutions may get bank licenses as per these guidelines. We appreciate the complexities of these issues and we believe RBI s draft guidelines have largely been drafted well to meet the first of the above objectives. However, it is the second objective that we would like to dwell upon. Financial Inclusion & Draft Guidelines Of the 34 or so draft guidelines released, the references to the goal of financial inclusion are limited to the following points: Section F (Business Plan) (a) Applicants for new bank licences will be required to forward their business plan for the new banks along with their applications. The business models will have to address how the bank proposes to achieve financial inclusion. Section G (Others) (x) (a) The bank shall comply with the priority sector lending targets and sub-targets as applicable to other domestic banks, and (b) The bank shall open at least 25 per cent of its branches in unbanked rural centres (population up to 9,999 as per 2001 census) to avoid over concentration of their branches in metropolitan areas and cities which are already having adequate banking presence. Section G (Others) (xiv)

2 The promoter / promoter group with an existing NBFC, if considered eligible for a bank licence, will have two options: (a) Promote a new bank, if some or all the activities undertaken by it are not permitted to be undertaken by banks departmentally. In such cases, the activities undertaken by the NBFC which banks are allowed to undertake departmentally, will have to be transferred to the new bank, or (b) Convert itself into a bank, if all the activities undertaken by it are allowed to be undertaken by a bank departmentally. Under both options, the promoters will have to first set up a NOHC. Reserve Bank will consider allowing the new bank to take over and convert the existing NBFC branches into bank branches only in the Tier 3 to 6 centres. Existing branches of the NBFC in Tier 1 and 2 centres may be allowed to convert into bank branches only with the prior approval of RBI and subject to the existing rules / methodology applicable to domestic banks regarding opening of branches in these centres and also subject to maintaining 25% of the bank branches in unbanked rural centres (population up to 9,999 as per 2001 census) required of all new banks as specified in G(x) (b) above. Same type of banks... Different type of results? The current draft guidelines for licensing of new banks tread the same path in which the existing banks are travelling. Even though there is a mention of focus on financial inclusion and 25% of branches to be opened in rural areas, these norms are equally applicable to existing banks too. As per official figures, over 65% 1 of the population is currently unbanked in spite of various financial inclusion mandates set for existing banks by RBI. To expect proposed new banks to reach out to this otherwise untouched segment, while operating under similar regulations will be a recipe for failure! If new banks are expected to behave differently, they should be governed by suitably different norms as well! With approximately 2 of 3 households outside the purview of the formal banking sector, it is vital that RBI takes significantly different measures to make a dent on these statistics. Promoting financial inclusion We believe RBI could dramatically change the landscape of financial inclusion in the country by creating special banking licenses for financial inclusion. It is critical that the right entities are provided this license: 1. An obvious starting point would be to accord greater preference to those entities that have previously demonstrated a propensity to work with customers outside the purview of formal financial services. Institutions that have successfully deployed business models to provide financial services to those outside the banking realm may be more aligned to work towards the financial inclusion goal. 1 Source:

3 2. With a special banking license for financial inclusion, RBI may consider imposing following additional conditions on these entities to ensure that they remain focused on this segment: Objective Financial inclusion Savings products Financial inclusion Loan products Cap on RoE Minimum capitalisation of Rs. 500 Crores Suggested Norm 1. Balances in CASA and TD not to exceed a certain cap per customer. This cap could be set at Rs 2 Lakhs (to be automatically revised annually based on annual inflation rate). 2. Additional mandate can be that atleast 40% of these CASA accounts (both in numbers and in balances) should be from account holders who have no accounts with any other bank thus ensuring first time users are brought into the banking umbrella. This could be implemented by creating an information bureau for savings bank accounts along the lines of credit information bureau. With all banks information in digitised forms, creating a Savings Information Bureau should be simple. 1. To ensure that this Bank remains focussed exclusively on inclusiveness, there should be a cap on the loan exposure that this Bank can take on any individual or entity or entities within the same group. This cap may be set at Rs 50 Lakhs (to be automatically adjusted annually based on annual inflation rate) 2. A portion of loans should be compulsorily provided to those who have not availed of loans at other banks. 40% of all borrowers and 40% in terms of value of loans outstanding can be mandated for this purpose 1. Though there is general scepticism that a bank modelled on financial inclusion would not be sustainable, yet with the right regulatory support and with committed and passionate promoters, we believe it would be financially sustainable. 2. However to ensure that under no circumstance, such banks resort to profiteering and causing societal upheavals, there is a need to put a cap on the Return on Equity that such banks can generate, especially given the fact that they may very often operate in areas with inadequate competition from other banks. The average RoE of most banks in India including PSU banks is around 20-22%. Hence a cap of 25% RoE is recommended for such special licensee banks. If in any year, such banks generate an RoE beyond 25%, the excess of profits can be required to be deposited into some common pool of RBI which can be used for client education and protection by RBI. There is a general feeling that such banks should be given the benefit of a much smaller capital to start with. However we believe that for any entity to be allowed to offer banking

4 services, it is critical that it be of a certain size so that its capital base itself supports a certain level of stability and sustainability of that institution. Hence the currently recommended minimum capital of Rs. 500 Crores and to be enhanced over time to Rs Cr should be retained Mobile banking Leveraging Technology Special licensees should be allowed to deploy field personnel to conduct doorstep service by leveraging technology like mobile banking and hand-held devices. This will improve the customer access to these banks. Such licensees should be required to have Core Banking Solutions right from the start of their operations and should be able to offer anywhere banking as well as multi channel access to its clients right from the beginning 3. To compensate for meeting these additional conditions, the special licensees may be provided the following benefits: Sl No. Parameter Recommended norms 1. Financial inclusion and geography 1. It is very often assumed that financial inclusion is hampered only because of distance factors in rural areas. The reality is that even in cities, 2/3 rd of the population do not have any banking services because it is too small a value for the banks and the cost of serving them is too high to make it worthwhile. 2. Hence such banks should be allowed to open branches without restrictions. And since the type of clients they can service is well defined, wherever they open branches, it would only promote financial inclusion 2. Buffer period for SLR, CRR norms Graded scale of SLR,CRR norms to be provided for special licensees to adhere to. These may be structured so that within 5 years, the special licensee s SLR and CRR norms are similar to banknorms 3. Risk weightage All loans provided by these special licensees, may be provided a risk weight of 50%. Some might argue that these loans provided to the financially excluded have tended to be riskier for banks. However it must be understood that banks have, thus far, not been aligned with serving these customers. NBFCs such as Shriram Transport Finance Corporation have provided large number

5 of loans to financially excluded segments; and have still retained control on NPA levels. Thus if the proposed new banks build their entire business capabilities to service the low income groups, they should be able to build sufficient risk mitigants and the risk would be limited. Hence a risk weightage of 50% for its loans is recommended, which would help it reduce its cost of capital and thus pass on the benefits to its borrowers. 4. Promoters to bring in a minimum of 40% of the initial capital required to start the bank 5. Foreign shareholding to be restricted to 49% This allows the entry of only those promoters with deep pockets; and it might be reasonably expected that these promoters would prefer to operate a typical bank rather than one focused on financial inclusion. To encourage professionals and socially committed managements, it is crucial that this condition be relaxed. Professionals who have the passion, commitment and capability for financial inclusion can get other investors support in terms of funding its equity and hence there should not be any minimum holding defined for the promoter. Fit and Proper criteria and dispersed shareholding norms can always be used to ensure such banks are run properly. The current draft guidelines restricts foreign holding in new banks at 49% for 5 years. However when the bank is given a license based on the above conditions and compulsorily focuses on including the vast majority of unbanked masses and tiny, micro and small enterprises, then it is not very material what is the percentage of foreign holding. Further, the amount of risk capital available within India is significantly low and hence such banks may have to rely on foreign capital to meet capital norms. And with a cap on RoE, the usury element is anyway fully hedged 6. Proprietary ATM cards Special licensee banks to be allowed to issue proprietary ATM cards for customers whose accounts have a balance below a certain amount, which will not be operable in other bank ATMs