Report and Recommendation of the President to the Board of Directors

Report and Recommendation of the President to the Board of Directors Project Number: 49207-001 November 2015 Proposed Equity Investment and Loan RBL Bank Supporting Financial Inclusion Project (India) This is an abbreviated version of the document approved by ADB's Board of Directors that excludes information that is subject to exceptions to disclosure set forth in ADB's Public Communications Policy 2011.

CURRENCY EQUIVALENTS (as of 30 October 2015) Currency unit Indian rupee/s (Re/Rs) Re1.00 = $0.01528 $1.00 = Rs65.434 ABBREVIATIONS ADB Asian Development Bank CAR capital adequacy ratio DB&FI development banking and financial inclusion ESMS environmental and social management system GDP gross domestic product IFC IPO MFI MSMEs NBFC International Finance Corporation initial public offering microfinance institution micro, small, and medium-sized enterprises nonbank financial company NPA nonperforming asset PSL priority sector lending RBI RBL Reserve Bank of India RBL Bank SHG self-help group SME Small and medium-sized enterprises TA technical assistance NOTES (i) The fiscal year (FY) of the Government of India and RBL Bank ends on 31 March. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2015 ends on 31 March 2015. (ii) In this report, "$" refers to US dollars. Vice-President Director General Director Team leader Team members D. Gupta, Private Sector and Cofinancing Operations T. Freeland, Private Sector Operations Department (PSOD) C. Engstrom, Private Sector Financial Institutions Division, PSOD A. Cheema, Investment Specialist, PSOD I. Aguilar, Social Development Officer, PSOD J. Chenoweth, Senior Counsel, Office of the General Counsel M. Driver, Investment Specialist, PSOD J. Gomez, Safeguards Officer, PSOD A. Kumar, Investment Officer, PSOD B. Quang, Safeguards Specialist, PSOD S. Sasaki, Senior Safeguards Specialist, PSOD S. Shah, Principal Investment Specialist, PSOD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page I. THE PROPOSAL 1 II. THE FINANCIAL INTERMEDIARY 1 A. Investment Identification and Description 1 B. Business Overview and Strategy 3 C. Ownership, Management, and Governance 4 III. THE PROPOSED ADB ASSISTANCE 4 A. The Assistance 4 B. Implementation Arrangements 5 C. Value Added by ADB Assistance 5 IV. DEVELOPMENT IMPACT AND STRATEGIC ALIGNMENT 5 A. Development Impact, Outcome, and Output 5 B. Alignment with ADB Strategy and Operations 6 V. POLICY COMPLIANCE 6 A. Safeguards and Social Dimensions 6 B. Anticorruption Policy 7 C. Investment Limitations 7 D. Assurances 7 VI. RECOMMENDATION 7

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on (i) a proposed equity investment of the Indian rupee equivalent of up to $51,000,000, and (ii) a proposed loan of up to $100,000,000 to RBL Bank (RBL) for the Supporting Financial Inclusion Project in India. 1 II. THE FINANCIAL INTERMEDIARY A. Investment Identification and Description 2. Real gross domestic product (GDP) expanded at an average annual rate of 7.8% from FY2005 to FY2014, helping the country to reduce poverty from 37.2% in FY2005 to 21.9% in FY2012. 2 Although India weathered the global financial crisis relatively well, growth slackened during FY2012FY2014 as a result of (i) tighter monetary policy to counter persistently high inflation; (ii) the lack of consensus on some policy and regulatory issues; and (iii) the adverse effects of a decrease in global demand. 3 Since mid-2014 growth has rebounded, helped by increased political certainty, several policy actions, lower commodity (oil and non-oil) prices, improved business and consumer confidence, and reduced external vulnerabilities. GDP growth was 7.3% for FY2015. According to Asian Development Bank (ADB) estimates based on recently revised data, India s GDP growth is expected to increase to 8.2% in FY2016, benefiting from lower inflation (the result of supportive monetary policy), and increased capital expenditure. 4 3. Finance sector overview. The Indian finance sector is still developing, with banks playing the dominant role in providing funding. As of FY2014, India s finance sector comprised 94 commercial banks and 57 regional rural banks. Of the domestic banks, 26 were governmentowned banks and 20 private sector banks operating in India. Performance of the private sector banks has generally exceeded that of most government- owned banks, with exceptions such as State Bank of India, in terms of growth, asset quality, efficiency, and profitability, and they now account for 19% of credit. After growing at an average rate of 17.2% between FY2009FY2014, average credit growth for the banking sector slowed to 13.8% in FY2014 due to the macroeconomic slowdown. Gross nonperforming assets (NPAs) for the banking sector, as per the definition of the Reserve Bank of India (RBI), weakened from 2.4% in FY2010 to 4.6% in FY2015. 5 Furthermore, loans undergoing restructuring increased from 3.3% to 6.5% from FY2010 to FY2015. 6 The minimum total capital adequacy ratio (CAR) for FY2015 stands at 9.63% of risk weighted assets and is expected to increase to 11.5% in a phased manner by FY2019 due to Basel III implementation. 4. Notwithstanding the size of the banking sector, access to finance in India remains a key issue with 47% of people being unbanked. 7 Many private sector banks activities are 1 The design and monitoring framework is in Appendix 1. 2 World Bank. 2014. World Development Indicators. Washington, DC. 3 GDP growth of 5.1% in FY2012, 6.9% in FY2013, and 6.6% in FY2014. 4 ADB. 2014. Asian Development Outlook 2015. Manila. 5 NPAs for public sector banks are almost double those of private banks. 6 Changes in the RBI s definition of NPAs will include new restructured assets, as NPAs have put upward pressure on the sector s NPA data. Restructured assets refer to loans that are consolidated and the loan terms have been changed to avoid default by the borrower(s). 7 The percentage of unbanked people in India has declined from 65% in 2011. World Bank. 2014. Global Financial Inclusion Database. http://datatopics.worldbank.org/financialinclusion/country/india

2 concentrated in the growing urban areas with limited or no presence in rural areas. Access to credit is even more limited, with fewer than 14% of borrowers accessing credit through formal channels. 8 Key reasons for financial exclusion, from the demand side, include low literacy levels, lack of awareness of banking products, low irregular incomes and cultural obstacles. From the supply side, common constraints often include outreach in low density areas and low income populations, bank charges and unsuitable regulations and products. 9 Women in particular have difficulties accessing credit due to a number of factors, including lower income and lack of ownership of land and other forms of collateral needed to obtain credit. 10 The Government of India is encouraging banks to support financial inclusion to address access to finance issues. In August, 2014, the government launched an important initiative aimed at financial inclusion, the Pradhan Mantri Jan Dhan Yojana scheme (Prime Minister's People Money Scheme), which has far exceeded its target of opening 100 million accounts for poor families and as of November 18, 2015, has opened more than 192.7 million new accounts. 11 The directed lending norms of the RBI require that every domestic commercial bank and every foreign bank with at least 20 branches extend an aggregate of 40% of the adjusted net bank credit of the preceding year to the PSL sectors. 5. Micro, small, and medium-sized enterprise sector. Foremost amongst underbanked segments is micro, small, and medium-sized enterprises (MSMEs). According to the International Finance Corporation (IFC), there are 29.8 million MSMEs in India operating across all industries. 12 These businesses employ more than 69 million people. They include 2.2 million enterprises led by women and 15.4 million rural enterprises, many of which focus on primary agriculture activities. MSMEs account for 45% of Indian industrial output and 40% of exports. Lack of adequate access to finance has been one of the key constraints to growth. Financial institutions traditionally have limited exposure to MSME sector versus larger commercial enterprises, due to a higher risk perception, MSMEs limited access to immovable collateral, and nonstandardized documentation. The IFC estimates that the MSME sector s total requirement for financing is approximately $650 billion, of which $433 billion is for debt financing. 6. The rural and agriculture sectors are important to Micro, small, medium-sized enterprises. Rural and agriculture lending for food production and processing plays a key role for MSMEs. Approximately 850 million people live in rural India, representing 70% of the total population. 13 This group heavily depends on income from micro and small businesses, such as small-scale agriculture and fisheries. However, agriculture contributes to just 17% of GDP (as of FY2014) 14 due to low productivity and profitability. Lack of credit availability is a primary reason for low investment in the agriculture sector as it received only 11%12% of institutional credit 8 World Bank. 2014. The Global Financial Inclusion Database: Measuring Financial Inclusion around the World. 9 Keynote Address by Dr. K. C. Chakrabarty, Deputy Governor, Reserve Bank of India on Financial Inclusion Indicators on 5 November 2012 (https://www.rbi.org.in/scripts/bs_speechesview.aspx?id=749) 10 ADB. 2013. Country Partnership Strategy: India, 20132017. Manila; ADB. 2013. India Gender Equality Diagnostic of Selected Sectors. Manila. 11 http://www.pmjdy.gov.in/home 12 IFC Study: Micro, Small and Medium Enterprise Finance in India http://www.intellecap.com/sites/default/files/publications/ifc%20msme%20report.pdf 13 World Bank. Rural Population. http://data.worldbank.org/indicator/sp.rur.totl (accessed 12 Aug 2015). 14 World Bank. Indicators. http://data.worldbank.org/indicator/nv.agr.totl.zs

during FY2007FY2015. 15 The availability of affordable private credit for individuals via microfinance institutions (MFIs) and nonbank financial companies (NBFCs) could bring about significant change, as it could help farmers and rural dwellers to invest. 7. Investment rationale. Given the continued need to address access to finance issues for many customer segments and support the government s financial inclusion initiatives, ADB has sought to identify financial institution partners that have demonstrated the ability to reach underbanked segments on a profitable and sustainable basis. RBL has been a partner of ADB as a local currency lender in the Private Sector Operations Department s Microfinance Risk Participation and Guarantee Program since 2012. 16 RBL is one of the few private sector banks that has consistently achieved PSL targets working with lower income individuals and MSMEs, including agri-based customers (more than 18% of RBL s total credit went to the agriculture sector in FY2014). RBL s understanding of its customer segments and comprehensive underwriting systems have enabled it to maintain strong asset quality and profitability while achieving above industry average growth rates. It plans to continue on this growth trajectory and provide access to banking and financial services to 5 million underserved households by FY2020. Through a three-pronged approach of providing equity for growth, long-tenor debt, and technical assistance (TA), which will be approved separately, ADB will support the continued expansion of a bank that has profitably built financial inclusion as a core business. B. Business Overview and Strategy 8. RBL is a private sector bank established in 1943 to cater to MSMEs in the states of Maharashtra and Karnataka. Following a 2010 change in management, which implemented a successful turnaround strategy, the bank has emerged as one of the faster-growing banks in India with total assets of $4.4 billion, a loan portfolio at $2.3 billion, and a deposit base of $2.8 billion as of the end of FY2015. It now operates 183 branches across 13 Indian states serving over 1.3 million customers (as of FY2015). To support its growth plans by strengthening Tier I capital, RBL has filed a draft prospectus with the Securities and Exchange Board of India to undertake an initial public offering (IPO) of its shares (subject to regulatory approvals). The bank also plans to raise capital through a pre-ipo private placement. 9. RBL offers a comprehensive range of banking products and services customized to cater to the needs of its clients, with a focus on PSL to support underserved or unbanked customers. The bank s business segments consist of corporate and institutional banking, commercial banking, branch and business banking, agribusiness banking, and development banking and financial inclusion (DB&FI). As of FY2015, RBL s PSL book constituted 47.86% of its adjusted net bank credit, of which 19.41% was lent to the agriculture sector. 10. RBL is now well placed to start its next growth phase by expanding its agribusiness banking and DB&FI segments. RBL s growth strategy is to reach more regions with low penetration and new client segments via (i) branch network expansion; (ii) strengthening of its network of exclusive business correspondents; and (iii) development of its technology platform that supports innovative inclusive finance products, such as mobile banking and micro-atms 15 ADB. 2014. Report and Recommendation of the President to the Board of Directors: Proposed Loans and Technical Assistance Grant to Axis Bank Limited and Yes Bank Limited for Strengthening Rural Financial Inclusion and Farmer Access to Markets Project. Manila. 16 ADB. 2010. Report and Recommendation of the President to the Board of Directors: Proposed Microfinance Risk Participation Program. Manila.

4 (new handheld tablets). 17 These micro-atms will allow RBL to reach its customers and offer all the relevant products through handheld tablets in their homes, saving them a trip to a branch a journey that could take several hours in rural India and result in lost earnings. 11. RBL s strategy will be increasingly mapped to meet the needs of PSL segments. In the agribusiness banking segment, the bank s strategy is to cover the entire agricultural value chain and create a loyal customer base by offering a complete range of value-added products and services. In the DB&FI segment, it will continue to partner with select business correspondents, expand its reach, and provide last-mile delivery of its products and services in rural India through transaction points. RBL is also targeting women borrowers to try to achieve financial inclusion for women and progressive social change. Its plans include continued development of specific products for women borrowers and financial literacy training. The bank will also expand its small and medium-sized enterprises (SMEs) portfolio through the commercial banking business segment by focusing on industries that have good growth potential. C. Ownership, Management, and Governance 12. Ownership. Under RBL s transformation plan of 20102015, the bank consolidated its shareholding and strengthened its capital base by raising high-quality institutional capital. RBL has raised four rounds of equity funding since 2010 totaling $284 million with investments from reputed global institutions. 13. Governance. Under the leadership of Vishwavir Ahuja, who became managing director and chief executive officer in 2010, RBL brought in a highly respected and experienced board of directors to strengthen governance. The managing director and chief executive officer is the only executive director. The board consists of members with considerable professional expertise in banking, finance, agriculture, and other related fields. 14. Management. The transformation process of RBL started with the recruitment of accomplished professionals from the banking industry under the leadership of Vishwavir Ahuja, who has more than 30 years of banking experience. Before joining RBL, Vishwavir Ahuja was chief executive officer of the Bank of America in India. RBL s senior executive management team has a strong academic and professional background with a proven track record and experience. RBL has several management committees running the daily operations of the bank which includes committees for assets and liabilities, and credit and operational risk. A. The Assistance III. THE PROPOSED ADB ASSISTANCE 15. The proposed ADB assistance consists of (i) an equity investment of the Indian rupee equivalent of up to $51 million; and (ii) a 5-year loan of up to $100 million. ADB also expects to 17 Business correspondents are facilitators, including MFIs or social organizations employed by banks on a revenue share model, that service people at the bottom of the income pyramid. This is a business model used by certain banks in India to efficiently reach underserved segments and to fulfill PSL requirements. RBL has entered into exclusive partnership agreements with eight business correspondents. It carefully assesses its business correspondents based on their established track record and strong local relationships.

provide a capacity building TA grant of up to $800,000. 18 The TA will build the bank s risk management and information technology capabilities, specifically in its development of a customized loan origination system for agribusiness banking and DB&FI. 16. ADB s equity investment will be in the form of new shares subscribed via a pre-ipo private placement to be undertaken prior to RBL s stock exchange listing. It is anticipated that some existing international investors in RBL may also seek to increase their shareholdings through the private placement. B. Implementation Arrangements 17. Monitoring of the project will be carried out by ADB. 19 RBL will provide ADB with financial reports at pre-determined regular intervals and as requested, including (i) unaudited financial statements on a quarterly basis; (ii) audited financial statements on an annual basis; (iii) compliance certificates for financial covenants; (iv) reporting on the MSME, microfinance, and small farmer loan portfolios; (v) annual reporting on selected development indicators agreed between ADB and RBL; and (vi) annual implementation status of its environmental and social management system (ESMS) reports. C. Value Added by ADB Assistance 18. ADB is expected to provide the following value additions: (i) Support of financial inclusion. ADB s funding will help RBL continue to grow and reach underserved customer segments in India. Additional funding will also enable it to meet and exceed PSL targets a key government objective as well as expand its operations to some of the lesser developed states in India including Oddhisa, Chhattisgarh, Bihar and Uttar Pradesh. By supporting the capitalization of one of India s leading private banks focused on financial inclusion and providing debt financing, ADB has a unique opportunity to support PSL initiatives and increase financial services in rural India. (ii) Catalyze capital as a strategic shareholder. (iii) Provide access to longer tenor debt. Support women borrowers. ADB s assistance will also help to improve access to finance for women through a gender action plan. IV. DEVELOPMENT IMPACT AND STRATEGIC ALIGNMENT A. Development Impact, Outcome, and Output 19. Impact. The project will broaden access to finance for farmers and MSMEs. 20. Outcome. The outcome will be improved financial intermediation to farmers and MSMEs, with a specific focus on women borrowers, which will help boost investment in rural India, increasing farm income and employment. 21. Output. The output will be increased financial capacity of RBL to service MSMEs, farmers, and microfinance borrowers, with specific targets for women borrowers within these 18 The TA is estimated to cost $1 million, of which (i) $800,000 will be financed on a grant basis by ADB s Technical Assistance Special Fund (TASF-other sources); and (ii) $200,000 will be provided by RBL. 19 Details of Implementation Arrangements (accessible from the list of linked documents in Appendix 2).

6 segments. The project should contribute to the expansion of the finance sector s footprint in India s low-income rural economy to include underbanked and unbanked segments. In addition, ADB s TA will help RBL to reach the underserved. B. Alignment with ADB Strategy and Operations 22. Under ADB s Strategy 2020 and Midterm Review of Strategy 2020, ADB aims to strengthen the finance sector by supporting the development of financial infrastructure, institutions, and products and services; and by promoting inclusive growth. 20 The investment will assist RBL in its efforts to (i) expand its offerings to the low-income population across rural and semi-urban India; and (ii) provide long-term finance to deepen financial service availability to MSMEs and farmers, thus also supporting ADB s country partnership strategy for India, 2013 2017. 21 The project is also aligned with ADB s Gender Equality and Women s Empowerment Operational Plan, 20132020. 22 It is designed to have a gender equity theme and will directly provide and target financial services to women farmers and women MSMEs. The project will target women beneficiaries as borrowers and investors, and will therefore receive direct gender benefits. A. Safeguards and Social Dimensions V. POLICY COMPLIANCE 23. The project is classified as category FI for impacts on the environment, involuntary resettlement, and indigenous peoples. ADB s loan will support RBL s agribusiness and MSME portfolio, which is likely to have only a small number of minimal to limited adverse environmental impacts or risks (generally site-specific, largely reversible, and addressable through readily available prevention and mitigation measures). On the other hand, as ADB s equity funding will support the overall growth of RBL which may include RBL s corporate loans that may be considered environmental category A and that may have potential significant adverse environmental impacts. The operations of RBL are not expected to trigger involuntary resettlement impacts, including acquisition of land that will cause economic or physical displacement (including that of indigenous peoples). In the unlikely event of any involuntary resettlement and indigenous peoples impacts, the ESMS will provide guidance on matters pertaining to due diligence and corrective actions. RBL will apply ADB s prohibited investment activities list, ensure that investments using ADB funds will comply with applicable national laws and regulations, comply with ADB s Safeguard Policy Statement (2009), and establish and maintain an appropriate ESMS satisfactory to ADB before funding the proposed loan or equity. RBL has an existing ESMS that will be enhanced to satisfy ADB s Safeguard Policy Statement requirements prior to ADB funding. These enhancements will include developing appropriate environmental and social review procedures and providing training to facilitate ESMS implementation by MFIs and NBFIs; incorporating relevant provisions for subproject review by ADB for category A subprojects and ensuring that ADB Safeguard Policy Statement requirements are met; incorporating ADB s prohibited investment activity list in RBL s exclusion 20 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 20082020. Manila; ADB. 2014. Midterm Review of Strategy 2020: Meeting the Challenges of a Transforming Asia and Pacific. Manila. 21 ADB. 2013. Country Partnership Strategy: India, 20132017. Manila. 22 ADB. 2013. Gender Equality and Women s Empowerment Operational Plan, 20132020. Manila.

list; and incorporating climate change risk screening questions in RBL s due diligence questionnaire. RBL will also submit an annual environmental and social performance report on the status of its ESMS implementation. 23 Information disclosure and consultation with affected people will be conducted in accordance with ADB requirements. 24. The project is designed as having gender equity theme. RBL supports (i) rural women organized in credit self-help groups (SHG), and (ii) micro and small- sized business households across India by providing working capital to augment farm productivity and income opportunities. The bank will use business correspondents as intermediaries or directly service women SHGs. The SHG model ensures adequate participation of women in the decision making and reception of essential financial literacy training. RBL will assign capable staff to monitor the implementation of the gender action plan and reflect into the annual environmental and social performance monitoring report. RBL will comply with national labor laws and, pursuant to ADB s Social Protection Strategy (2001), will take measures to comply with the internationally recognized core labor standards. RBL will report regularly to ADB on (i) its compliance with such laws and (ii) the measures taken. Information disclosure and consultation with affected people will be conducted in accordance with ADB requirements. B. Anticorruption Policy 25. RBL was advised of ADB s policy of implementing best international practices relating to combating corruption, money laundering, and the financing of terrorism. ADB will ensure that the investment documentation includes appropriate provisions prohibiting corruption, money laundering, and the financing of terrorism, and remedies for ADB in the event of noncompliance. C. Investment Limitations 26. The proposed loan and equity investment are within the medium-term industry, group, and single investment exposure limits for non-sovereign investments. D. Assurances 27. Consistent with the Agreement Establishing the Asian Development Bank (the Charter), ADB will proceed with the proposed assistance upon establishing that the Government of India has no objection to the proposed assistance to RBL. 24 ADB will enter into suitable finance documentation, in form and substance satisfactory to ADB, following approval of the proposed assistance by the ADB Board of Directors. VI. RECOMMENDATION 28. I am satisfied that the proposed equity investment and loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve (i) the equity investment of the Indian rupee equivalent of up to $51,000,000; and (ii) the loan of up to $100,000,000 23 Summary Poverty Reduction and Social Strategy; Safeguards and Social Dimensions Summary; Financial Intermediary: Environmental and Social Management System Arrangement (accessible from the list of linked documents in Appendix 2). 24 ADB. 1966. Agreement Establishing the Asian Development Bank. Manila.

8 to RBL Bank for the Supporting Financial Inclusion Project in India, from ADB s ordinary capital resources, with such terms and conditions as are substantially in accordance with those set forth in this report, and as may be reported to the Board. 16 November 2015 Takehiko Nakao President