Indian Banking Sector Reforms: Licensing of New Banks in the Private Sector

Entry of New Banks in the Private Sector

As per the guidelines for licensing of new banks in the private sector issued in January 1993, RBI had granted licenses to 10 banks. Based on a review of experience gained on the functioning of new private sector banks, revised guidelines were issued in January 2001. The main provisions/requirements are listed below:

  • Initial minimum paid-up capital shall be Rs. 200 crore; this will be raised to Rs. 300 crore within three years of commencement of business.
  • Promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time; their contribution of 40 per cent shall be locked in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one year of bank’s operations.
  • Initial capital other than promoters’ contribution could be raised through public issue or private placement.
  • While augmenting capital to Rs. 300 crore within three years, promoters need to bring in at least 40 percent of the fresh capital, which will also be locked in for 5 years. The remaining portion of fresh capital could be raised through public issue or private placement.
  • NRI participation in the primary equity of the new bank shall be to the maximum extent of 40 per cent. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter, equity participation shall be limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI contribution to foreign equity can be met through contribution by designated multilateral institutions.
  • No large industrial house can promote a new bank. Individual companies connected with large industrial houses can, however, contribute up to 10 per cent of the equity of a new bank, which will maintain an arms length relationship with companies in the promoter group and the individual company/ies investing in equity. No credit facilities shall be extended to them.
  • NBFCs with good track record can become banks, subject to specified criteria
  • A minimum capital adequacy ratio of 10 per cent shall be maintained on a continuous basis from commencement of operations.
  • Priority sector lending target is 40 per cent of net bank credit, as in the case of other domestic banks; it is also necessary to open 25 per cent of the branches in rural/semi-urban areas.

“Our industry did not oppose the entry of private bankers because we knew they will not be able to reach out to the rural markets” states, G.M. Bhakey, president of the State Bank of India Officers Association. “Even after privatisation not more than 10 per cent of the Indian population can afford to open accounts in private banks.”

The new generation private sector banks have made a strong presence in the most lucrative business areas in the country because of technology upgradation. While, their operating expenses have been falling as compared to the PSU banks, their efficiency ratios (employee’s productivity and profitability ratios) have also improved significantly.

The new private sector banks have performed very well in the FY2000. Most of these banks have registered an increase in net profits of over 50%. They have been able to make significant inroads in the retail market of the public sector and the old private sector banks. During the year, the two leading banks in this sector had set a new trend in the Indian banking sector. HDFC Bank, as a part of its expansion plans had taken over Times Bank. ICICI Bank became the first bank in the country to list its shares on NYSE.

The Reserve Bank of India had advised the promoters of these banks to bring their stake to 40% over a time period. As a result, most of these banks had a foreign capital infusion and some of the other banks have already initiated talks about a strategic alliance with a foreign partner.

The main problems concerning the nationalized / state sector banks are as follows:

  1. Large number of unprofitable branches
  2. Excess staffing of serious magnitude
  3. Non Performing Assets on account of politically directed lending and industrial recession in last few years
  4. Lack of computerization leading to low service delivery levels, non-reconciliation of accounts, inability to control, misuse and fraud etc
  5. Inability to introduce profitable new consumer oriented products like credit cards, ATMs etc

The private’s edge

Technology- The private banks have used technology to provide quality service through lower cost delivery mechanisms. The implementation of new technology has been going on at very rapid pace in the private sector, while PSU banks are lagging behind in the race.

Declining interest rates- in the present scenario of declining interest rates, some of the new private banks are better able to manage the maturity mix. PSU Banks by and large take relatively long-term deposits at fixed rates to lend for working capital purposes at variable rates. It therefore is negatively affected when interest rates decline as it takes time to reduce interest rates on deposits when lending has to be done at lower interest rates due to competitive pressures.

NPAs- The new banks are growing faster, are more profitable and have cleaner loans. Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money.

Convergence- The new private banks are able to provide a range of financial services under one roof, thus increasing their fee based revenues.

  • prashantn

    To me, the below point is the most important one.
    “To contain the possibility of “holding out” if an industrial / business house comes under severe stress, industrial and business houses may not be allowed to use the brand name and logo of the Group.”