Differentiated Banking in India


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

RBI hopes to open the window soon the first for differentiated licenses like payment banks and then open the 'on-tap' licenses for universal banks. On-tap licensing means that the RBI window for granting banking licenses will be open through the year and not every tenth years.

Under the Differentiated Bank Licence (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 licence, 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 Differentiated Bank Licensing could enable unlocking potential of these opportunities as it encourages niche banking by facilitating specialization thereby reducing potential non-optimal use of resources. Each of the niches has the potential to be individually large to sustain significant balance sheets and specialized entities can play a major role in all of them.

First, in the current round of licensing, RBI not only recognizes diversity but encourages it. It can do so by giving licenses to applicants with diverse and specialist business models that focus on specific customer segments, products, and technology and process platforms. More importantly, it needs to show flexibility in regulation, and not ask all banks to look the same in the short run. Financial regulation is about consumer protection and micro-prudential regulation, and not homogenization.
 
Second, RBI needs to start thinking about Differentiated Banking Licenses. Why should we have only one type of license? Why can’t we have a utility bank – one that provides only transaction services (e.g. security related services such as custodian, trade related services, etc) and does not lend or borrow (significantly)? Why can’t we have a payment specialist bank or home loan banks (one that can take deposits but lend only in form of home loans, by far the safest lending for Indian banks)? Everyone talks about financial inclusion, so why can’t we have an inclusion bank – one that serves only the bottom of pyramid customers?
 
Such specialist banks will be expected to focus on their own individual niches and strengthen their capabilities in serving these niches as a bank - through access to payment systems, ability to raise deposits, regulatory oversight, etc. The presence of such banks will make the system less monolithic and hence better placed to face economic cycles. With Differentiated Banking Licenses, we will have banks that do not face boom and bust at the same time. Reduced correlations between banks will give lower systemic risk.
 
Issuing Differentiated Licenses, however, will require that RBI has to become more sophisticated in how regulations are drafted. RBI's regulatory staff will need to understand each business model, and write regulations about consumer protection and micro-prudential regulation that cater to the unique features of that business model. These regulations will have to differentially use the main tools of micro-prudential regulation – capital adequacy and reserve requirements, regulatory audits, reporting and compliance -- so as to achieve the desired failure probability, while recognizing differences in business models. RBI will also have to ensure that there is no regulatory arbitrage that is created across different types of banks.
 
International Experience and Practice 

Globally, some countries like USA, Australia, Singapore, Hong Kong, London and Indonesia, are practicing Differentiated Bank Licensing model. These countries are typically open economies and large and growing financial sector (in terms of its contribution to GDP) seem to be favoring Differentiated Licensing Policy. What is interesting is that the policy of differentiated licensing is followed in Malaysia and Brazil in spite of the fact that promoting financial inclusion has been an important thrust in the Central Bank’s developmental role in these countries. The criterion for differentiation for the purposes of issuing differentiated licences could be anchored either to capital conditions, as is practiced in Indonesia or to the activity as is the case in Australia, Singapore and Hong Kong. The supervision will vary from bank to bank depending on the type of licence the bank undertakes. For instance, in Singapore there are five types on branch licences — full bank, qualifying full bank (QFB), wholesale bank (WB), offshore bank and representative bank.
 
Nachiket Mor Report: 

The multi-member panel  led by ex-ICICI Bank Executive Director Nachiket Mor, set up by the Reserve Bank of India (RBI)has called for establishing Differentiated Lenders, including one for small businesses and low-income households. The bank for small businesses, called the 'Payments Banks', will focus on providing primary services to the people. "Given that their primary role is to provide payment services and deposit products to small businesses and low- income households, they will be restricted to holding a maximum balance of Rs. 50,000 per customer. Payments banks shall have a minimum capital requirement of Rs. 50 crore, one-tenth of what a full-service bank requires, since they will have a near-zero risk of default and maintained that existing lenders should be allowed to have payments banks as a subsidiary. The payments banks can be created by converting prepaid payment issuers (PPIs). There are more than two dozen PPIs that provide mobile wallets or cards that customers can use to make payments with the money that’s stored in them. They can gradually convert themselves into banks and even others can join them. Over a period of time, they can start offering other services as well.
 
The panel suggested a slew of dedicated banks to be formed, including the 'wholesale banks' which will lend big amounts but should not rise over Rs. 5 crore from a single depositor. The report suggested a bank dedicated to funding infrastructure projects. This comes in the backdrop of projection that infrastructure sector would require an investment of $1 trillion during the 12th Plan (2012-17). At present, the country has a universal banking system wherein lenders serve all the needs. However, there have been a lot of issues due to which the idea of differentiated banking has been gaining ground.

A differentiated license will allow a bank to offer products only in select verticals, such as project financing, or focus only on a certain banking service, like in the case of payment banks. They will have to set up shop with all compliances in the next 18 months.
 
Unlike a universal banking license which is a blanket license that allows banks to offer a range of services, a differentiated license from the RBI will allow a bank to offer specialized services in select verticals – such as project financing, mortgage banking, industrial financing etc. Currently in India, the RBI issues a universal banking license to both domestic as well as foreign banks. All banks in the country retain access to the central payments and settlement system and are blanketed by the deposit insurance cover.
 
Why, then, is RBI considering differentiated banking now?

In a country like India, the presence of varied financial institutions that have developed niche businesses has brought great variety to the finances sector. Each such institution has specialized in specific functions – gold loans, infrastructure financing, auto loans, micro financing etc. To bring them all under the RBI umbrella, currently they need to be issued a universal banking license, forcing them to diversify into businesses they have no experience or expertise in. issuing of differential banking licenses, however, is likely to promote better utilization of financial resources, bring depth to core activities, and allow institutions to focus on specific needs and customer segments.

The Reserve bank of India (RBI)’s proposal to issue differentiated banking licences appear to have caught the imagination of foreign banks. The RBI’s guidelines on sub standardization didn’t really excite foreign lenders in the country. However, Bankers say several mid-sized foreign lenders are keen to apply for such a licence, as and when RBI decides to offer these. Of the 43 foreign banks in India, only four or five are engaged in full-fledged banking. The rest are doing specialized banking business, though they have been given a universal banking licence. It makes sense for them to opt for a differentiated banking licence and maintain focus on their core activity.
 
Potential Candidate
 
Differentiated licensing must be given only on basis of ownership and capability. “When you try and do it on different rules and regulations, it inevitably leads to financial tussles because you end up with non-level playing field and you create arbitrage which becomes very difficult to compete with. Presently, priority sector norms mandate every commercial bank to lend 40per cent(now 50 per cent as per recommendation of Nachiket Mor committee) of their net bank credit to agriculture, small and medium enterprises every fiscal regulatory arbitrage must be prevented. The lucrative parts of business will get a lot of players, whereas for universal bankers, some parts of business are cross-subsidized. Intense competition in lucrative businesses would make it difficult to maintain other parts (subsidized) of the business.



Friday, 21st Oct 2016, 07:28:59 AM

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