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RBI Discussion Paper on Banking Structure - Outside View by S.S. TARAPORE
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RBI Discussion Paper on Banking Structure
Oct 7, 2013

In August 2013, the Reserve Bank of India (RBI) set out a Discussion Paper on 'Banking Structure in India-The Way Forward.'

Backdrop of existing structure

A virtue of the paper is that it is eclectic in its approach and thereby facilitates an informed debate.

The present commercial banking system consists of 26 public sector banks, seven new private sector banks, 13 old private sector banks, 43 foreign banks, 4 local area banks and 64 regional rural banks. Thus there is a diversified structure, which could be developed and strengthened over time. The penetration of banking has, over the years, been significant, with banking business (deposits plus credit) as a percentage of the GDP rising from 5.8 per cent in 1951, to 56.5 per cent in 2012. The population per branch came down from 64,000 in 1969 (i.e. the year of nationalisation of banks) to 12,300 in 2012. Despite this increase in penetration, only 40 per cent of the adult population has access to bank accounts. The break-up of rural credit, as between institutional and non-institutional credit, is revealing.

Share of Institutional and Non- Institutional Agencies in Rural Credit (%)
Year Institutional Non-Institutional
1951 7.2 92.8
1961 14.8 85.2
1971 29.2 70.8
1981 61.2 38.8
1991 64.0 36.6
2002 57.1 42.9

With increasing difficulties, since 1981, in reducing non-institutional credit, the major thrust, in recent years by the government and the RBI towards financial inclusion is only appropriate.

Public sector banks continue to predominate in total assets, though the proportion has come down from 85 per cent in 1995-96, to 73 per cent in 2011-12.

Evolving role of banking structure

The discussion paper envisages a few global banks, some national banks, some regional banks and a number of small local banks-essentially as envisaged by the Narasimham Committee I (1991).

Growth of private banks

In the recent period, there has been considerable discussion on the granting of licences to new private sector banks. Under the 1993 guidelines, 10 new private sector banks were licensed, while under the 2001 guidelines, two new banks were licensed. Under the 2013 guidelines, 27 applications have been received, which are to be screened by an external expert committee, chaired by the redoubtable Bimal Jalan.

A salutary feature is that unlike in the past, when the window for applications for new banks was periodically opened for a short while, in future, the applications window will be kept open on tap. While the appointment of the chairman is clear, it is not clear whether the membership of the committee has been settled. 'Calculated leaks' i.e. strategic testing of waters, seemed to imply that the other members would be a non-executive member of the RBI Board, government officials and the three financial regulators other than the RBI i.e. regulators of financial markets, insurance and pensions. The tentative composition of the committee is rather ominous, as it would reinforce the overbearing role of the government in the bank licensing procedure; this is a matter of great concern.

It would appear that the timetable of release of licences by January 2014 may not be adhered to. While the extant guidelines provide for a minimum capital of Rs 500 crore, thought is also being given to selectively reducing the minimum capital to enable small banks to emerge.

In contrast, the Standing Parliamentary Committee on Finance has reportedly advocated an enhancement of the minimum capital to Rs 1,000 crore, but simultaneously voiced serious apprehensions about allowing industrial houses to apply for bank licences. The issue of allowing industrial houses to set up banks has been extensively discussed and after detailed deliberations, it was decided to allow industrial houses to apply for bank licences.

The present columnist has been an early advocate of allowing industrial houses to apply for bank licences. Memories of the pre-nationalisation period, when industrial houses dominated the banking scene, are no longer relevant, as there are concentration ratios and prohibition on connected lending, which would prevent earlier malpractices from re-emerging. In the upshot, it would appear that political economy considerations will prevail and the actual granting of licences will take place only after May 2014.

Way forward for PSBs

Preliminary calculations indicate that to comply with the Bank of International Settlements Basel III framework, the government would need to inject Rs 90,000 crore into public sector banks, which would be a severe burden on an already strained fisc. The present approach to recapitalisation of the PSBs is flawed in that the weaker the bank, the greater the government support, which then results in PSBs as a group, veering towards the weakest in the system. The Narasimham Committee II (1998) recommended that the government's holding could be reduced from 51 per cent to 33 per cent and that the reduction would not undermine the government's policy objectives.

While this recommendation of Narasimham Committee II was pre-eminently sound, it has been rejected by governments of vastly different political hues. As such, the 51 per cent minimum rule is unlikely to be changed. Nonetheless, two modifications need to be given serious consideration.

First, within the 51 per cent minimum government ownership, C Rangarajan had, some years ago, suggested that the 51 per cent minimum holding should include the holdings of select institutions, which would remain in the public sector, such as the Life Insurance Corporation, the Oil and Natural Gas Commission (ONGC) and Indian Oil Corporation ( IOC).

Secondly, the government should plough back the entire dividend it receives back into the concerned bank. This way the stronger PSB would grow faster than the weaker PSBs. This would strengthen the overall PSB system.

While mergers of large banks have been mooted, there are strong political economy pressures, which put off any serious consideration of mergers of PSBs. As such, this proposal is unlikely to see the light of day.

Concluding observation

Given the political economy constraints, it would appear that changes in the banking system will be incremental and that there will not be any big bang reforms.

Please Note: This article was first published in The Freepress Journal on October 07, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.


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