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How feasible is it to turn into a bank? - Views on News from Equitymaster

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How feasible is it to turn into a bank?

Jun 29, 2013

After a decade of granting bank licenses to two players, the Reserve Bank of India (RBI) is all set again to welcome new banks in the private sector. While numerous players wanted to set up a bank post the announcement from the regulator in February 2013, the enthusiasm today stands replaced with more of skepticism. Few conglomerates have come forward intending to opt out of the race for new bank licenses with their respective managements finding the move too risky. Much contemplation and viability analysis has prompted the groups to turn negative. While the stringent regulatory guidelines are to be blamed, let us delve more into the details of the eligibility criteria put forth by the RBI for the applicants of banking licenses.

Key criteria to set up a bank

  1. Minimum paid-up capital of Rs 5 bn
  2. Promoters should be deemed "fit and proper" by RBI
  3. Should have a successful track record of sound credentials of 10 years
  4. Business models should not be misaligned with banking model
  5. Bank must be set up through a wholly-owned non-operative financial holding company (NOFHC)
  6. Company with public stake of 51% shall hold 51% in NOFHC; NOFHC must not have any exposure to the promoter group
  7. Cash reserve ratio (CRR), Statutory liquidity ratio (SLR) should be maintained right from the inception
  8. 25% of the bank's branches must be in unbanked rural centres (with population up to 9,999)
  9. Cap on foreign investment set at 49% for the first 5 years
The above guidelines, however, have thrown up challenges for the new bank aspirants.

How did these factors discourage few to pull out of the race?

There lies ample opportunity in our banking services starved nation where merely 40% of the adult population has access to basic banking. Ironically, with the deadline fast approaching to submit the applications for new banking licenses, the number of enthusiasts seems to have diminished. The stringent regulatory requirements have made many entities rethink their strategies to set up a bank. Few already believe that setting up a bank could be a value destructor to their existing business operations rather than it proving a value creator. The current set of guidelines is believed to have adverse economic and operational impact particularly on the larger NBFCs. Mahindra Finance, for instance, which was believed to be a strong contender for bank set-up, has dropped plans to enter mainstream banking. That is because these norms are discouraging to the existing business objectives of the company. To illustrate, rigorous compliance of cash reserve ratio (CRR), statutory liquidity ratio (SLR) and priority sector norms right from inception would imply higher liabilities. Furthermore, in the event of non-fulfillment the company may even attract penalties.

Additionally, the RBI mandates for the new bank to have one-fourth of the branch network in the unbanked areas. This would certainly disincentivize the large NBFCs such as Mahindra Finance in seeking banking license as the company would be compelled to convert each of its 670 branches into a bank branch over a period of 18 months. Therefore, it would be difficult to make profits in the initial years. Other such entities that may have to start from a clean slate are also raising concerns that they may have to make huge investments. Besides, heavy capital requirements, synchronization of existing business operations with core banking activities, pooling of suitable human capital, asset allocation and more importantly complexities pertaining to the treatment of bad loans and provisions will only add to the worries of the applicants. While these concerns are more at micro level, the macro level disturbances have raised fears too. Given the economic slowdown, many applicants fear the risk of timing to maiden start with the banking business.

Therefore, though banking business prima facie sounds lucrative and profitable on a longer term horizon, the process of setting up a bank is more comprehensive and uncompromising. Moreover, the RBI this time around sounds more demanding than earlier with the end objective of financial inclusion taking precedence.

We trust that the winners of the bank licenses would be the corporate entities that are not looking for short term gains for the group, but are keen to become stable players in Indian financial sector.

Shweta Daptardar-Mane

Shweta Daptardar-Mane, has an MBA (Finance) degree and over five years of equity research experience. She passionately tracks the Banking and Finance industry and follows the macro developments in the economy, particularly the central bank monetary policy. She is deeply inspired by not only Buffett's investment acumen, but also by his infectiously charismatic, down-to-earth persona. Shweta is the contributor to our large cap franchise, StockSelect.


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