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Banking Sector Overhaul (21 November 2020)

Banking Sector Overhaul (21 November 2020)

Why in News:

RBI recommends banking industry overhaul.

Context:

A working group at the RBI has recommended a series of changes that could transform the country’s banking landscape by paving the way for large industrial conglomerates to set up banks. The proposals could also allow large non-banking finance companies and niche payment banks to convert into lenders.

Background:

The Internal Working Group (IWG) of the Reserve Bank of India (RBI), headed by PK Mohanty, was constituted by the RBI in June 2020, to review the extant ownership guidelines and corporate structure for private sector banks in India.

Summary of the Debate

Recommendations made by RBI:

  • Bank Promoters: Banking regulations be amended to allow large industrial houses to act as so-called bank promoters, meaning they could take a significant stake in a lender, something the central bank has strongly resisted in the past.
  • Banking Licences: Giving banking licences to large corporate or industrial houses after necessary amendments to the Banking Regulation Act, 1949.
  • Size of the Stake: Increasing the size of the stake that promoters in private banks can hold to 26% from the current 15% over a 15-year time frame.
  • NBFC: NBFC or shadow bank with assets of Rs 500 billion and above, including those which are owned by a corporate house may be considered for conversion into a bank after 10 years of operations.
  • Conversion to Small finance bank: Payments banks with 3 years of experience can be eligible for conversion into a small finance bank.
  • Initial Capital Requirement: The minimum initial capital requirement for licensing new banks should be enhanced from  Rs 500 crore to Rs 1000 crore for universal banks, and be raised to Rs 300 crore from Rs 200 crore for SFBs.
  • Non-promoters: For non-promoter shareholdings a uniform cap of 15% of the paid-up voting equity share capital of the bank instead of a current tiered structure.
  • Non-operative Financial Holding Company: They should continue to be the preferred structure for all new licenses to be issued for universal banks. However, it should be mandatory only in cases where the individual promoters/promoting entities/ converting entities have other group entities.

Regulation of NBFCs:

  • There is a case for the light-handed regulation of NBFCs continuing, but regulation on regular banks becoming much tougher, because at the end of the day, the average depositor expects all his deposits to be fully secured.
  • NBFC sector has served the Indian economy very well, because it has taken credit to categories of consumers who wouldn’t have got it, they have had focus in sectors which banks would have found it difficult to serve in that manner. They have also been flexible enough and the light-handed regulation of NBFCs was good.
  • The RBI is now doing is a little modest calls correction that if it is too big to fail or a systemic problems, the RBI will regulate them little more or supervise some more to become banks.
  • Within NBFCs, they have improved the supervisory and regulatory mechanisms, but so far they have not overdone it.
  • They moved very quickly to rescue of NBFCs in the early days of the serious crisis caused by the covid lockdown.

              Different Types of NBFC and Difference between Each Other

Impact of covid-19 pandemic on Banking Sector:

  • Around 19 sectors, which were not under stress before the pandemic but have been hit it, account for Rs 15.5 lakh crore of debt.
  • The low investment demands are likely to cause a considerable decline in loan growth in coming years.
  • Migrant people who were got into the banking habit who were getting money, they have now been disconnected.
  • Most of the poor people have resorted to private money lending.
  • Corporates has been hard hit given the slowdown, resulting in rising defaults.

Way Forward:

  • There is a need of a banking system where all deposits are fully secured to give enough confidence to the retail saver and to the entire economy. Every depositor in a bank should feel that all his deposits are secure, he has to pay an insurance premium for it.
  • RBI has to be convinced about the need to allow NBFCs, banks and large companies to get into the banking space.
  • Banks are clearly lagging; they are not investing sufficiently in technology to be ahead of trends that are there, both in terms of payments, in terms of savings, etc.
  • There should be some willingness on to inject additional capital if required in some banks.
  • The government and RBI should be more liberal if banks have to get over this covid crisis, especially expansion of banking reaching the right people and the farmers.
  • Government should also look in to how to get the new design of banks so that they answer the uniquely Indian situation.
  • The reforms which government is considering have to consider the marginalized sectors who have been affected during covid.

Important points made by the Guests

Sidhartha, National Economic Editor, TOI

  • Regulation wise, RBI is one of the best regulators we have in the country and globally also they are rated very high and in terms of supervision, what they do is that they inspect the books every year, they inspect the branches, the functioning of banks every year.
  • The problem arises is that at times, the follow-up in terms of supervision is missing for instance, in case of ILFS, there were red flags which were raised during the whole inspection and the supervision exercise, but at some point of time, the action was missing.
  • RBI has emerged as wiser from this whole experience. So, after the ILFS crisis what it has done is that it is very closely monitoring the top 100 NBFCs and wherever required they getting the promoters and the shareholders to get in more capital, so that there is enough capital and there is no crisis in the sector.
  • Also, in terms of way, banking is done in India is a lot different between RBI and the government. Banks are not allowed to collapse because of two reasons:
    • The whole issue of protection of depositors.
    • In terms of systemic issue that may arise even a smallest bank if it goes down can create ripples across the system.

Ajay Shankar, Former Secretary, DIPP, Ministry of Commerce & Industry, GOI   

  • Regulators have a challenge of arriving at the right point in the regulatory spectrum where they support economic activity and it’s always a tough call.
  • Right now, the regulator is reacting to a few developments over the last many quarters. The one is that the large NBFCs were found to be very rightly regulated and some of them ended up by getting into difficulties and posing a systemic risk to the financial sector.
  • So, the regulatory response has to be in increasing regulation but not over regulating so that they don’t have the flexibility to serve the needs of a dynamic economic which they were doing well till some NBFCs went into difficulty.
  • The route of allowing the larger NBFCs into becoming a bank is a way of making sure that the large NBFCs who are too large or too big to fail, come into a tighter regulatory regime which is there for banks. So, it addresses the problem of basically giving a route to the large NBFCs who are too big to fail to convert themselves into a bank.
  • As far as the promoters being industrial houses are concerned, this was an anxiety which the RBI had earlier and it flew from the history of the Indian banking sector.

Dr. P. Pullarao, Economist

  • The large private banks as of now, they are financing in a very limited way to one section of people.
  • Small Finance Bank is a very useful, targeting of certain audiences who have no access to banking.
  • For long, we expected RBI to allow the corporate houses to come into the banking sectors and RBI has a lot of reluctance.
  • The two most successful private banks, the HDFC and ICICI, they have a lot of foreign equity in it.

 

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