Licensing new banks in private sector is a bold step in the path of financial sector reforms. In fact the ball was set rolling after the Union Finance Minister in his Budget Speech 2010-11 made a significant announcement that: “RBI is to consider giving some additional banking licenses to private sector players.” The objective is clear and loud: to extend banking outreach, instill competitive efficiency, bring in new technology and achieve inclusive growth. RBI issued the final “Guidelines for Licensing of New Banks in the Private Sector” in February 2013 after taking into account the important amendments to the Banking Regulation Act, 1949, feedbacks received from the public, and consultation with the Central Government. An innovative corporate structure of the promoters of banks is prescribed. Entities / groups in the private sector and entities in the public sector shall be eligible to promote a bank through a Non–Operative Financial Holding Company (NOFHC). The corporate structure is designed to ring-fence the banks from spill-over risks from other entities of the group. Financial inclusion has emerged as major policy plank of the Centre and RBI. The task is challenging with large population and the geographical spread of our country. The data released from the recent Census of India shows that only 54.4 per cent of rural households have access to banking services RBI received 26 applications for bank license. On the recommendations of a High Powered Committee headed by Dr Bimal Jalan, former RBI Governor, RBI, issued "in principle" approval to two entities viz IDFC ( an NBFC) and Bandhan( NBFC-MFI) to set up banks. Presently they are functioning as NBFCs; they need to obtain license from RBI under Sec 22 of the Banking Regulation Act, 1949. . The earlier experimentation of bank licensing infused the much needed competition and technology in the banking sector. Notably, the business models adopted by these banks support class banking, profit maximization and risk-taking. Expectedly, the new generation banks would bring an evolutionary change to meet the “needs of modern economy” and alongside “improve access to banking services” to the lower strata of the society.

1. Licensing new private sector banks
Indian experience
D. Mishra
Licensing new banks in private sector is a bold step in the path of
financial sector reforms. In fact the ball was set rolling after the Union Finance Minister in his
Budget Speech 2010-11 made a significant announcement that: “RBI is to consider giving some
additional banking licenses to private sector players.” The objective is clear and loud: to extend
banking outreach, instill competitive efficiency, bring in new technology and achieve inclusive
growth.
Ten banks were licensed under the 1993 policy, with enhanced entry requirements and
inclusion expectations. The experience was mixed; five of these banks subsequently closed,
merged, or were acquired by other banks. The policy was revised in 2003 and further raised
entry requirements; laid out inclusion targets; and specifically excluded large industrial houses
from being promoters of new banks. Two banks ( Kotak Mahinda Bank, Yes bank) were licensed
under this policy.
In 2011, guidelines were issued for a new window of bank licenses with the stated
objective of issuing a limited number of new licenses to foster competition; reduce costs;
improve service; and promote financial inclusion. While several elements of the 2003 policy
have been retained, entry requirements have been raised to minimum capital of INR 5 billion
and capital adequacy of 12 percent. The key difference with past policy is the express eligibility
of large industrial houses to promote new banks; or to convert NBFCs they own into new banks.
It may be recalled that, RBI issued the final “Guidelines for Licensing of New Banks in the
Private Sector” in February 2013 after taking into account the important amendments to the
Banking Regulation Act, 1949, feedbacks received from the public, and consultation with the
Central Government.
An innovative corporate structure of the promoters of banks is prescribed. Entities /
groups in the private sector and entities in the public sector shall be eligible to promote a bank
through a Non–Operative Financial Holding Company (NOFHC). The corporate structure is
designed to ring-fence the banks from spill-over risks from other entities of the group.
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2. The financial holding company should be:
 Non operative in nature, and be wholly owned by the promoter/ promoter group.
 Registered as a non-banking financial company (NBFC) with RBI. Financially sound
entities with successful track record would be permitted to set up NOFHC.
The minimum paid up voting equity capital of the bank is kept at Rs.5 billion; of which
the NOFHC can hold a minimum of 40 per cent. Share holding in excess of 40 per cent need to
be brought down to 40 per cent within three years and ultimately, share holding of NOFHC shall
divested to 15 per cent in 12 years.
One important milestone in the release of RBI guidelines is the amendment of the BR
Act, 1949 giving necessary powers to the banking regulator to carry out the regulatory
mandate effectively. These include:
i) Acquisition of 5 per cent or more of the paid up capital or voting rights of banks needs
previous approval of RBI.
ii) RBI may increase the ceiling on voting rights from 10 per cent to 26 per cent.
iii) Enabling RBI to call for information on and inspect associate enterprises of the banks.
iv) Regulatory power for supersession of Board .of Directors of the banks in the private
sector.
One area which needs attention is the penalty level for breach of regulation.
Recalcitrant banks need to be adequately penalized by the regulator. For better enforcement
of regulation, the penal provisions under the statute should be revised in line with of
international best practices.
All over the world, opinion is divided whether industrial houses should own a bank. One
view is that as banks are repository of public deposits, and highly leveraged the potential risks
from the industrial houses arising out of economic slowdown may get transmitted to the bank.
Thus, there is apprehension that real sector risks may be transferred to financial sector. There
is a temptation on the part of promoters to get into self dealing. Many eminent economists,
past and present like R.K. Hazari, Joseph E. Stiglitz do not support industrial houses owning
banks. On the other hand, the proponents opine that industrial houses may bring in innovation,
superior technology and rich experience of professional management.
Financial inclusion and financial stability have emerged as major policy plank of the
Centre and RBI. The task is challenging with large population and the geographical spread of our
country. The data released from the recent Census of India shows that only 54.4 per cent of
rural households have access to banking services

3. RBI received 26 applications for bank license. On the recommendations of High Level
Advisory Committee ( HLAC) headed by Dr Bimal Jalan, former RBI Governor, RBI, issued "in
principle" approval to two entities viz IDFC Ltd ( an NBFC) and Bandhan Financial Services (
NBFC-MFI) on April 2, 2014, to set up banks. The "in principle" approval will be valid for 18
months. After further scrutiny of the applications, they will be considered for grant of banking
license under Sec 22 of the Banking Regulation Act, 1949. Effectively, the new banking licenses
would be rolled out before October 2, 2015. The HLAC has also recommended to consider of
the application of the Department of Posts separately in consultation with the central
government.
Another milestone development in the banking regulatory arena is the differentiated
banking license. In 2007, RBI had issued a concept paper and a discussion paper in 2013 on
differentiated banking license. Differentiated banking in various forms do exist in Hong Kong,
Singapore and few other countries. After study and deliberation, RBI issued guidelines on small
finance banks and payment banks, in November 2014. RBI has received in February 2015, 72
applications for small finance banks and 41 applications for setting up of payment banks. Final
names are yet to be released. These new category of banks would surely deepen financial
inclusion, by use of modern technology.
In future, the Reserve Bank intends to revise the guidelines appropriately and move to a
regime of “on tap” license. In essence, RBI is working on the guidelines for "continuous
authorisation" of universal banks, and differentiated banks on lines of recommendations of the
Committee on Financial Sector Reforms ( Chairman: Dr Raghuram Rajan).
[The author is a former Chief General Manager, Reserve Bank of India]
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