22 July 2014 EY Regulatory Alert Draft guidelines for licensing of Small Banks and Payments Banks in the private sector Introduction Regulatory Alerts cover significant regulatory news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest regulatory issues. For more information, please contact your EY advisor. The Reserve Bank of India (RBI) while granting in-principle approval to two applicants for set-up of new banks in the private sector indicated that it would work on a policy of having various categories of differentiated bank licenses which would permit entry of a wider pool of entrants in the Indian banking sector. Further, the Honourable Finance Minister of India while presenting the Finance (No 2) Bill, 2014 in the Indian parliament on 10 July 2014 announced, inter alia, that to meet the credit and remittance needs of small businesses, unorganised sector, etc, the RBI would create a framework for licensing small and other differentiated banks. In view of the above, the RBI has recently issued draft guidelines for licensing of payments banks and small banks for public comments (Draft Guidelines). This alert summarises the salient features of the Draft Guidelines.
Background The RBI had on 27 August 2013 issued a policy discussion paper titled Banking Structure in India The Way Forward wherein it was observed, inter alia, that there is a need for niche banking in India and differentiated licenses could be a desirable step in this direction, particularly for infrastructure financing, wholesale banking and retail banking. In furtherance to the above, the RBI has on 17 July 2014 issued the Draft Guidelines. Any suggestions/ comments on the Draft Guidelines may be sent to the RBI on or before 28 August 2014. The RBI has indicated that guidelines on continuous authorisation of universal banks would be issued separately. This alert summarises salient features of the Draft Guidelines. Further, the Committee on comprehensive Financial Services for Small Businesses and Low Income Households, constituted by the RBI under the Chairmanship of Dr Nachiket Mor, in its report released in January 2014, inter alia, recommended that that given the difficulties being faced by the Pre-paid Instruments Issuers (PPI issuers) 2, and the underlying prudential concerns associated with the said model, the existing and new PPI issuer applicants should instead be required to apply for a Payments Bank licence or become Business Correspondents (BCs) 3. Additionally, while granting an in-principle approval to two applicants to set-up banks in the private sector, the RBI on 2 April 2014 indicated that it would work on a policy of having various categories of differentiated bank licenses which would permit entry of a wider pool of entrants in the Indian banking sector. Small Banks Eligible promoters Resident individuals/ professionals with 10 years of specified experience will be eligible to set up small banks. Further, existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs) and Local Area Banks (LABs) 4 can also opt for conversion into small banks after complying with all legal and regulatory requirements. Preference will be given to professionals from banking/ financial sector, NBFCs and MFIs to set up small banks. Local focus and ability to serve to serve small customers will be a key criterion in providing licenses to small banks. Scope of activities Further, the Finance Minister while presenting the Finance (No 2) Bill, 2014 on 10 July 2014, announced, inter alia, that a structure would be put in place for continuous authorisation of universal banks in the private sector and that RBI would create a framework for licensing of small banks and other differentiated banks. A small bank shall primarily undertake basic banking activities of acceptance of deposits and lending to small farmers, small businesses, micro and small industries and unorganised sector entities. Other simple financial services activities can be undertaken with the prior approval of the RBI. 2 PPI Issuers are permitted to receive cash deposits from customers, store them in a digital wallet, and allow customers to pay for goods and services from their digital wallet. Currently 27 PPI Issuers are authorised by the RBI under the Payment and Settlements Act, 2007. 3 BCs are agents used by banks to extend the reach of their branches by reducing costs and improving outreach. 4 LABs were authorised by the RBI vide its Press Release dated 24 August 1996 and were conceived as low cost structures which would provide competitive and financial intermediation services primarily in rural and semi-urban areas.
In order to maintain the local feel and culture, the area of operation of the small banks shall be restricted to contiguous districts in a homogenous cluster of States/ Union Territories. Branch expansion for the initial three years will require prior approval of the RBI, after which, based on experience, RBI may consider relaxing this condition. Capital requirement Other conditions Small banks shall comply with the priority sector lending targets and sub-targets as applicable to the existing domestic banks. While submitting the branch expansion plan to the RBI for approval in the initial three years, the small banks shall plan to open at least 25% of its branches in unbanked rural areas 6. The minimum paid-up voting equity capital for small banks (including existing NBFCs/ MFIs/ LABs which opt for conversion) shall be INR 1 billion. Payments Banks Eligibility criteria Each small bank shall maintain a capital adequacy ratio 5 of 15% of its risk weighted assets on a continuous basis, subject to any higher percentage as may be prescribed by the RBI. Prudential norms Small banks will be required to put in place a robust risk management framework and will need to comply with all prudential norms and regulations of the RBI as applicable to existing commercial banks including the requirement of maintenance of a Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). Small banks will be required to have a well-diversified portfolio of loans and advances spread over its area of operation: Maximum loan size and investment limit exposure to single/ group borrowers/ issuers would be restricted to 15% of its capital funds; and At least 50% of its loan portfolio should constitute loans and advances of size upto INR 2.5 million in order to extend loans primarily to micro enterprises. 5 The capital adequacy ratio would need to be computed under the simplified Basel I standards. Existing non-bank PPI issuers, NBFCs, corporate BCs, mobile telephone companies, super market chain companies, real sector co-operatives and public sector entities may apply to set-up a payments bank. Existing banks can invest in the equity share capital of payments banks to the extent permitted under section 19(2) of the Banking Regulation Act, 1949 7 (Banking Act). Scope of activities Payments banks will be permitted to undertake only the following restricted activities permitted to banks under the Banking Act: Acceptance of demand deposits i.e. current deposits and savings bank deposits. The maximum balance that can be raised by payments banks will be initially restricted to INR O.1 million per customer (such limit may be subsequently raised by the RBI); 6 Areas having population upto 9,999 as per latest census 7 No banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding 30% of the paid-up share capital of that company or 30% of its own paid-up share capital and reserves, whichever is less.
Payments and remittance services through various channels including branches, BCs and mobile banking; Issuance of pre-paid instruments as per prescribed instructions; Internet banking; and Functioning as a BC for other banks. Payments bank would be required to have at least 25% of access points in the rural centres. weighted assets on a continuous basis, payments banks will be required to maintain a leverage ratio of not less than 5% i.e. its outside liabilities should not exceed 20 times its net worth/ paid-up capital and reserves. Key common provisions applicable to small banks and payments banks Registration and approval process Deployments of funds and prudential norms Prudential norms (other than those applicable to loans and advances given by banks) of the RBI such as cash balances with the RBI/ scheduled commercial banks, CRR and cash in hand shall be applicable to payments banks. Further, payments bank will be required to invest all its balance monies in government securities/ treasury bills with maturity of upto one year for maintenance of SLR. Registration to be obtained as public limited companies under the Companies Act, 2013 and licensing with the RBI to be sought under section 22 of the Banking Act. Promoters/ promoter groups to satisfy fit and proper criteria which would be assessed by the RBI on the basis of their past record of sound credentials and integrity; financial soundness and successful track record of at least five years in running their businesses. Promoter s contribution and voting rights Payments banks would be permitted to participate in the payment and settlement system and will have access to the inter-bank uncollateralised call money market and the collateralised CBLO market for the purpose of temporary liquidity management. Capital requirement The minimum paid-up voting equity capital for payments banks shall be INR 1 billion. Payments banks would be required to maintain a net worth of INR 1 billion at all times. In addition to maintenance of a minimum capital adequacy ratio 8 of 15% (or such other higher percentage as may be prescribed by the RBI) of its risk 8 The capital adequacy ratio would need to be computed under the simplified Basel I standards. Promoters to have a minimum initial contribution of 40% of the paid up voting equity capital with a lock-in period of five years. The above stake shall be reduced in the following phased manner: Shareholding in excess of 40% to be brought down to 40% within 3 years from the date of commencement of business; 30% within 10 years from the date of commencement of business; and 26% within 12 years from the date of commencement of business. Similar to the restrictions applicable to private sector banks, voting rights in small/ payments banks will be capped at 10% (which can be raised to 26% by the RBI in a phased manner). Further, acquisition of 5% or more of the equity shares will require prior approval of the RBI.
Foreign shareholding in the small/ payments bank will be as per the extant Foreign Direct Investment policy. Other conditions Restriction on setting-up subsidiaries to undertake NBFC acivities. Further, other financial and non-financial activities of the promoters, if any, should be kept distinctly ring-fenced and not comingled with the banking and financial services business of the small/ payments bank. The Board of the small/ payments bank should have a majority of independent directors. Operations of the small/ payments bank to be fully networked and technology driven from the beginning. Banks to have a high powered Customer Grievance Cell to handle customer complaints. Comments Both, small banks and payments banks are niche or differentiated banks. The primary objective of setting up small banks and payments banks is to further financial inclusion by extending banking facilities to the underserved and unserved sections of the Indian population. The small banks should aid in disbursing small-ticket loans to farmers and businesses and thereby, increase their participation in the India growth story. Whereas, on the other hand, payments banks will cater to marginalised sections of society, including migrant labourers, for collecting deposits and remitting funds. Further, since the RBI has indicated that it will be issuing licenses on a selective basis, it will be incumbent for the applicants to have sound credentials apart from integrity and a good track record (with RBI and other regulators/ agencies such as Income Tax, Enforcement Directorate, etc).
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