A Justified Licence Raj

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The banking sector remains licence-ruled and licences will not be auctioned—for good reasons

Under a newly legislated policy, the Reserve Bank of India is soon to allot new licences for private banks. The motive of this move, according to the Government, is to ‘ensure that Indian banking grows in size and sophistication to meet the needs of a modern economy’. In the context of banking, just how primitive India’s economy is can be gauged from the fact that two-thirds of the country is still ‘unbanked’, with no access to even a no-frills bank account. So the new reforms’ main emphasis is financial inclusion of the poor, says Ashvin Parekh of Ernst & Young. Yet, he adds, new banks would also spur competition and perhaps a round of bank mergers as a result, with the biggest of the lot able to extend large enough loans to India Inc for grander plans such as overseas acquisitions.

Before all that, bank licence seekers would need to worry about viability. Serving the poor is mandatory. In fact, since India’s bank nationalisation of 1969, which forced banks to fan out across the country and serve millions more, this is the first time that agenda is being pursued with such vigour (after all, the Centre’s cash transfer project depends on it), and existing banks have made quite some progress—at least on paper—over the past two-and-a-half years. While the first set of private bank licences awarded in 1993 enhanced the sector’s vibrancy, efficiency and customer friendliness, it failed to serve the country’s have-nots. “With the kind of balances—just Rs 100-300 odd—in financial inclusion accounts,” says Parekh, “the financial viability of these operations has remained elusive.” Now, newly licensed banks must open a quarter of their branches in unbanked areas. The assumption is that private capital backed by technological innovation will yield a way round the old viability problem.

Licence seekers, however, would have another worry too: that of eligibility. Since public funds are entrusted to banks, auctions are out of the question. Licences would only be issued to private entities with ‘impeccable track records’ on a strict set of criteria, and they would have to place themselves under tight regulatory oversight. Controversially, for the first time, business houses can also apply for licences—on the condition that they place the entire group’s accounts under the RBI’s watch, a measure to contain any conflict of interest. Global observers such as Nobel Laureate Joseph Stiglitz consider this much too ‘risky’, but Indian financial sector watchers are optimistic that new banks could be a ‘game changer’—though only if “new aspirants believe that banking is not merely an opportunity but a big responsibility as well”, as Parekh of E&Y puts it.