Editorial Today – Banking Sector – Reforms and Road Ahead

Banking Sector – Reforms and Road Ahead

Background:
New Banking Licences-

• On 2nd April 2014, Reserve Bank of India  issued long awaited bank licenses to two new financial institutions. Bandhan Financial Services , the micro-lending company, and  Infrastructure Development Finance Company (IDFC), the infra lending company.
• Additionally,RBI indicated that further bank license will be based on the experience from this licensing exercise, which may help to put banking license ‘On Tap’.
• RBI said that the remaining 23 banking license aspirants, who could not qualify in this round for a full-fledged banking license, may either apply in future rounds or apply for  Differentiated Bank Licenses  (DBL)  rather than for the full license, under the proposed framework.

Why in news?
Structural changes in the banking industry architecture have been hinted by the  Indian central bank in its first bi-monthly monetary policy for fiscal 2017.

What structural changes?

• RBI is ready to release norms for bank licensing on tap soon.
• It is also exploring the possibility of licensing other differentiated banks and a discussion paper on that is expected in the next few months and it could include wholesale banks, custodian banks and investment banks.

Differentiated Bank License (DBL)

• Under the Differentiated Bank License (DBL) model, banks will be allowed to offer products only in select verticals, like Infrastructure, Project Financing and Payment Service etc. as indicated in the Nachiket Mor Committee report.
• The regulator is in a view to allow a wider pool of entrants into banking under  DBL  rather full-fledged banking license, which needs more capital, experience etc.
• Indian market is still untapped and there are diverse opportunities in the banking and financial landscape reflecting significant macro-economic growth potential.
• And DBL could enable unlocking potential of these opportunities as it encourages niche banking by facilitating specialization thereby reducing potential non-optimal use of resources.

FEATURES OF DIFFERENTIATED BANKS:

• These are banks for serving different segments of customers.
• These are highly specialised banking entities focusing on target group of customers.
• These are driven by innovation and technology perspectives
• The products and range of services provided by these banks are also differentiated keeping in view the customised needs of the customers
• These serve the purpose of different segments of society e.g. women bank opened in Mumbai is one such example and similarly there may be banks for physically challenged people, students, younger employees and professional
• The rates of interest charged will depend upon the nature of the clientele the banks will possess
• An entity with a Differentiated Bank License  need not engage in basic banking activities nor do they need to adhere to priority sector obligations.

Payment Banks

• Payments banks can collect deposits of up to Rs.1 lakh, provide payments and remittance services and distribute third-party financial products.
• They won’t be able to give loans and issue credit cards, but can provide debit cards and Internet banking services.
• Essentially, they will mobilize deposits on behalf of other banks, acting as a business correspondent.

Small banks

• Small banks, on the other hand, will offer loans.
• They have to give 75% of their loans to the so-called priority sector, and 50% of the loan portfolio should constitute small loans of up to Rs.25 lakh, even as they will be subject to all prudential norms like any other commercial bank.
  

• While payments banks will stick to their niche and try to take away other banks’ fee income and look for opportunities in the remittance space, successful small banks can graduate to universal banks after a few years.

Wholesale banks

• The bulk of Indian banks’ bad assets is in the infrastructure sector. Many had rushed to lend, often under pressure from the government, without understanding the risks associated with infrastructure financing. Besides, they didn’t have the long-term resources to support such loans.
• Wholesale banks can fill in this gap. They will be able to generate long-term funds and probably won’t be subjected to the reserve requirements such as cash reserve ratio (CRR) and statutory liquidity ratio (SLR).
• Some of the large non-banking financial companies that raise funds from the wholesale market and lend to corporations can become wholesale banks. A few foreign banks, too, will be happy to enter this space, even though they have reservations about local incorporation, which RBI has been pushing for.

Custodian banks

• Custodian banks don’t dabble in commercial and retail lending; they safeguard a firm’s or individual’s financial assets such as stocks, bonds, currency, commodities, metals and money market instruments like commercial papers.
• They arrange settlements of sales and purchases, ensure delivery of securities and offer accounting, legal, compliance and tax support services to customers such as commercial banks, insurance firms, mutual funds and pension funds in multiple jurisdictions around the world.
• Unlike commercial banks, which offer loans using cash deposited with them, custodian banks can lend securities.
• Currently, Clearing Corp. of India Ltd provides guaranteed clearing and settlement functions for transactions in government securities, foreign exchange and derivatives as well as money markets, while there are two depositories—National Securities Depository Ltd and Central Depository Service (India) Ltd. Once RBI issues the guidelines for custodian banks, clarity will emerge on the future of these entities.

Investment banks

• An Investment Bank (IB) is a financial intermediary that performs a variety of services.
• Investment banks specialize in large and complex financial transactions such as underwriting, acting as an intermediary between a securities issuer and the investing public, facilitating mergers and other corporate reorganizations, and acting as a broker and/or financial adviser for institutional clients.
• Some investment banks specialize in particular industry sectors. Many investment banks also have retail operations that serve small, individual customers.

Conclusion

• India needs more banks of different shapes, sizes and business models. The banking regulator is responding to this need.
• At the same time, it is also trying to de-risk the balance sheets of state-run banks. The consolidation move, if it succeeds, will lead to larger but fewer universal banks.
• Many more, relatively smaller banks offering specialized services will complete the landscape.
• If RBI is serious about it, banking in India will never be the same again.