The new benchmark for potential entrants to the Indian banking
sector reflects the Reserve Bank of India's (RBI's) intention
to control the risks of the Indian banking sector more
effectively following the global financial crisis of 2008. The
draft guidelines, which lay down the criteria for corporate
groups to secure permission for establishing banks in India,
were released on August 29 2011. The subjective elements
towards eligibility of the promoters include, 'diversified
ownership, sound credentials and integrity'. The final
guidelines will be issued after the RBI has reviewed feedback,
comment and suggestions on the draft version.
The guidelines state that entities having more than an
aggregate 10% income or assets in real estate, construction and
capital market activities, in particular broking activities,
are not allowed to promote banks in India. The objective is to
prevent risks from these activities spreading to the banking
sector, which is based on fiduciary principles as depositors'
money is involved.
Another strong objective of the guidelines is to regulate
the risks of banks more effectively by ring-fencing all
regulated activities under the umbrella of a non-operative
holding company (NOHC). New banks will be set up only through a
wholly-owned NOHC to be registered with the RBI as a
non-banking finance company (NBFC), which will hold the bank as
well as all other financial companies in the promoter group.
This might have implications for the existing structure of
corporate groups, as a successful licensee may need to
restructure its group holdings in order to comply with the
In addition, there is a minimum capital requirement of Rs 5
billion (US$88 million). The NOHC shall hold a minimum 40% of
the paid-up capital of the bank for a period of five years from
the date of licensing of the bank. The NOHC could start with a
higher shareholding, but it has to be brought down to 40%
within two years, to 20% within 10 years, and to 15% within 12
years from the date of licensing. The aggregate foreign
shareholding in the new bank shall not exceed 49% for the first
five years after which it will be as per the extant policy.
On the corporate governance side, the guidelines state that
at least 50% of the directors of the NOHC should be totally
independent of the promoter/ promoter group entities, its
business associates, and its customers and suppliers.
guidelines, new banks will have to open 25% of their
branches in rural areas
The guidelines also state that exposure of the bank to any
entity in the promoter group shall not exceed 10%, and the
aggregate exposure to all the entities in the group shall not
exceed 20% of the paid-up capital and reserves of the bank.
Finally, the bank shall open at least 25% of its branches in
the unbanked rural centres (population up to 9,999 persons).
This is expected to make banks more accessible to less
Many legal practitioners from the banking sector find the
new regulations to be overly protectionist. In particular, they
find the capitalisation requirement to be hard to follow, and
they also find the requirement to establish 25% of branches in
rural areas to be unreasonable.
Akil Hirani, managing partner at Majmudar & Partners,
says: "There are not enough considerations on market reality as
the government intends to set up these new banking rules. Some
of the requirements have significant impact on the
profitability of the banks. For example, the requirement for
potential entrants to set up 25% of their branches in rural
areas is unviable to some investors."
He adds: "The banking activities in these areas are mostly
taken care of by domestic banks, as they normally have agendas
aligned to the central government. However, the private banks
do not have such agendas, nor do they have specialties in
taking care of businesses in rural areas. For many of the
newcomers, such requirements are difficult and unviable."
Others, such as Kotak Mahindra Capital chief legal and
compliance officer Ajay Vaidya, believe that the requirement
for 25% rural branches was always a likely response to
criticism received over microfinance institutions. They argue
that the benefits include bringing institutionalised banking
systems to less populated centres around the country.
One concern is that the Indian government's new rules might
prevent it from realising its objective of attracting more
foreign players, says Hirani, particularly when the capacity of
local banks is insufficient to finance India's fast growing
economy. "The Indian government has strong incentives for
attracting more investment from foreign banks as they tend to
offer better financial products, and at lower cost, in order to
compete with protected local banks," he says. "So despite the
fact that the new banking rules appear to raise the benchmark
for incoming banks, it doesn't mean that the government is
reluctant towards the entrance of foreign banks."
Hirani adds: "It is purely a regulatory effort to better
control banking-related risks in India. However, they are just
doing that in the wrong way without comprehensively balancing
the interest between establishing an investment-friendly
environment for the banking sector and introducing more
regulations to control risks."
The RBI's new set of draft guidelines for licensing new
banks has certainly caused a stir among the legal fraternity,
but they are unlikely to be implemented anytime soon as they
are still under amendment and discussion. Various matters, such
as the removal of restrictions on voting rights and RBI's
approval for change of shareholding limitations, remain under
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