The document discusses the evolution of banking regulation in India, highlighting the Reserve Bank of India's (RBI) initiatives to grant new banking licenses to private sector entities to enhance financial inclusion and competition. Following the recommendations from various committees, significant guidelines and eligibility criteria were established for bank licensing, including scrutiny of applicants' financials and operational history. The RBI granted 'in-principle' approval to two entities, and amendments to the Banking Regulation Act, 1949 were made to facilitate the establishment of new banks in response to modern economic needs.

1. Banking Landscape in India
LICENSING NEW BANKS
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”. Taking it forward, RBI, in August 2010 released a “Discussion
Paper on the Entry of New Banks in the Private Sector”. The discussion paper mentions
that “vast segments of the population, especially the underprivileged sections of the
society, have still no access to the formal banking services”. According to it, more
number of banks would infuse competition, improve quality of service, enhance banking
outreach and ultimately foster inclusive growth.
Banking coverage
The position of banking coverage for the last three years is asunder:
March 2011 March 2012 March 2013
Number of Commercial banks
(Of which RRBs)
167
(82)
173
( 82)
157
(64)
Number of bank branches 74,130 81,240 88,562
Number of ATMs
+
74,505
95,686 1,14,014
Total banking outlets in villages 116,20
8
181,753 2,68,454
[Source: Report on Trend and Progress of banking in India, 2011-12, 2012-13, Reserve
Bank Of India]
The Report on Trend and Progress of banking in India, 2011-12, mentions that: “ the
growth in the financial and banking sector has to keep pace with growth in the real
sector .”

2. Licensing of banks: Past Experience
After the nationalisation of 14 banks in 1969, no new banks were set up. The
Committee on the Financial System (Narasimham Committee I, 1991) recommended for
setting up new banks in the private sector to start a new generation of banks to infuse
competition and bring technological upgradation. In 1993, RBI issued guidelines on
entry of new banks and the first wave of licenses was given to 10 banks in the private
sector. The experience with banks promoted by individuals has not been encouraging; out
of the four banks promoted in 1993, only one has survived. The second phase guidelines
were issued in January 2001. Two banks were given license; their transition path has
been smooth. RBI did not feel the need to issue further licenses as the banking sector was
in process of consolidation.
RBI Discussion Paper
The RBI discussion paper of August 2010, touched upon international practices, Indian
experience, extant ownership and governance guidelines. It raised the following critical
issues:
 Entry level capital
 Promoters contribution, caps on promoters share holding
 Eligibility criteria:
o Whether corporates, industrial houses can be allowed to promote new
banks.
o Whether NBFCs can be converted into new banks or promote new banks.
 Share holding by foreign investors including NRIs.
The discussion paper received large number of responses from general public, banks,
NBFCs, consultants, industrial houses, etc. RBI also held discussions with trade,
business bodies, Indian Banks Association for their views. Thereafter, RBI issued draft
guidelines in August 2011.
Paradigm shift

3. There is differing perceptions on industrial houses promoting or owning banks. The
2001 guidelines on entry of new banks explicitly prohibited industrial houses promoting
new banks, although industrial/ business houses are permitted to promote and own
NBFCs. Globally, while Australia, Brazil, Canada, European Union, France, Germany,
Hong Kong, United Kingdom, South Africa, Taiwan do not put restrictions on industrial
houses setting up banks, there are restrictions in Japan, South Korea and USA. In a path-
breaking recommendation, the High Level Committee on Fuller Capital Account
Convertibility, July 2006, had suggested that RBI should evolve policies to allow
selectively, industrial houses promoting new banks.
A recent IMF update ( 2012) on the “Financial system stability assessment of
India” states: “ International experience has supported the prudent policy of disallowing
industrial houses from promoting and owning banks.” Some economists fear corporate
conflict of interest. Nevertheless, Financial Times, September 26, 2012 reported that
Bankhaus Lampe a 160-year old private bank in Germany promoted by an industrial
house remained unscathed in the Global Financial Crisis. A spokesman of the bank
explained that: “Industrialists are more prepared to act counter-cyclically than people
generally are in the banking industry”. This view has less support.
The Committee on Financial Sector Reforms (Chairman: Raghuram G. Rajan)
constituted by Government of India in its report released in 2008 has recommended to
allow more entry to private deposit-taking small-finance banks for broadening access to
credit. The Committee calls for greater regulatory oversight.
The RBI draft guidelines set out the overarching regulatory principle, pre-
conditions for the new banks. Some of the more important requirements are:
i) Entities engaged in real estate business, stock broking should not be allowed to
promote banks as such activities can potentially transmit risk to the bank and banking
system.
On the other hand, existing NBFCs are eligible to promote/ convert to a new bank.
ii) Resident Promoter / promoter groups with diversified ownership , sound track record
of running business can be permitted to set up a new bank, only through a wholly-
owned Non-Operative Holding Company (NOHC). The objective is that the holding

4. company could ring fence the new bank from other activities of the group. This is an
innovative idea and IMF has appreciated it.
iii) The NOHC is required to be registered as an NBFC, and would be regulated by RBI.
It would hold a minimum of 40 per cent of the equity in the proposed bank, with a lock-
in period of five years.
iv) The initial minimum capital of a new bank shall be Rs. 500 crore.
v) The total foreign holding by way of FDI, FII and non-residents should be confined to
49 per cent for the initial five years.
Latest Developments
In toto, RBI received 27 applications by the dead line in July 2013, after which Tata Sons
and Videocon Group withdrew, leaving 25 applicants in the fray. In the first stage, the
applications were scrutinised by RBI to ensure eligibility of the applicants under the
Guidelines. The 25 applications were considered by a High Level Advisory Committee
set up in October, 2013 chaired by former RBI Governor, Dr. Bimal Jalan and
comprising three members (viz. Shri C.B. Bhave, former Chairman, SEBI; Smt. Usha
Thorat, former Deputy Governor, RBI; and Shri Nachiket Mor, Director, RBI Central
Board) to screen the applications, and to recommend name of applicants who comply
with the Guidelines. The HLAC submitted its recommendations to RBI on February 25,
2014 for its consideration.
According to RBI Press Release dated April 2, 2014, RBI examined the
quantitative and qualitative aspects of the applicants as per the criteria laid down in the
Guidelines. This included analysis of the financial statements of the key entities in the
group, 10 year track record of running their businesses, proposed business model for the
bank as well as the applicants’ demonstrated capabilities for running a bank, plan for
expanding inclusion, and culture of compliance and integrity demonstrated by the
applicant in its past activities. Based on all this, the RBI took a view of the “fit and
proper” status of the applicant.
RBI granted “in-principle” approval to infrastructure finance company, IDFC
Limited and Kolkata based microfinance firm Bandhan Financial Services Private
Limited, to set up banks. These two applicants were recommended as suitable for grant of

5. “in-principle” approval by the High Level Advisory Committee (HLAC) set up by the
RBI. The HLAC had also recommended that in the case of Department of Posts which
has applied for licence, it would be desirable for the RBI to consider the application
separately in consultation with the Government of India. The RBI has accepted the
recommendation of the HLAC.
The “in-principle” approval granted will be valid for a period of 18 months during
which the applicants have to comply with the requirements under the Guidelines and
fulfil the other conditions as may be stipulated by the RBI. On being satisfied that the
applicants have complied with the requisite conditions laid down by the RBI as part of
“in-principle” approval, they would be considered for grant of a licence for
commencement of banking business under Section 22(1) of the Banking Regulation Act,
1949. Until a regular licence is issued, the applicants would be barred from doing
banking business.
Way Forward
The important amendments to Banking Regulation Act, 1949 done in 2012 include :
to increase the cap on voting rights; to provide prior approval of RBI for acquisition of
5% or more of shares or voting rights in a banking company by any person; to empower
RBI to supersede the Board of Directors of banking company and appointing
administrators. RBI is expected to issue the final guidelines soon. This has paved the
way for setting up of new generation of banks “to meet the needs of the modern
economy”.
Revised on April 25, 2014
References:
1. The Economics Times, Infra Fund IDFC, Microfin Co Bandhan Get License to Bank,
April, 2014, Bhubaneswar Edition.

6. 2. Reserve Bank of India, Report on Trend and Progress in Banking , 2012-13, RBI,
Mumbai.

7. 2. Reserve Bank of India, Report on Trend and Progress in Banking , 2012-13, RBI,
Mumbai.