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TERM PAPER

FOR CORPORATE FINANCE COURSE


PGPPM 2013-15
TITLE
NEW LINCENSES IN INDIAN BANKING SECTOR

BY
V SURENDRAN,

PGPPM-1313020

G V RAMANA RAO, PGPPM-1313016

New Licenses in Indian Banking Sector


1. Introduction
Indian economy has been witnessing impressive growth consistently
for past many years excluding the exceptions in the very recent past,
partly due to global economic meltdown. This growth can sustain only with
the effective and efficient support from a robust finance system. Finance
sector was also a part of the economic reforms initiated in early nineties
and it could contribute effectively to the overall growth of the economy.
Finance sector experienced a growth rate which is at par with growth in
GDP during these years.
However, a comprehensive look at the performance of banking
sector will give better insights about the quality of its performance and
how far it could meet the overall objectives economic reforms expected
from this sector.

2. Post reform Performance of Banking sector


When Indian economy grew in value from 5.15 trillion in 1991 to 73.1
trillion in 2011, at a CAGR of 14 %, aggregate deposits of SCBs have grown
at a CAGR of 17.9%. Performance of the economy and its growth largely
depends on Bank lending. This has grown at a CAGR of 19.3% during
1991- 2011. Another measure of Banking sector performance, bank
credit/GDP has grown from 22.6% to 53.9% during the same period. Credit
to commercial sector increased from 30.3% of GDP to 57.6%. Moreover
average population of commercial banks branch, which is an indicator of
Financial inclusion, improved from 12,300 to 9,400 in Urban areas and
from 17,200 to 15,900

for semi urban and rural areas during 2005 to

2010. The all India weighted average improved from 15,500 to 13,400
during the same period. All these, shows significant indirect contribution
of Banking sector to the growth of the economic. Direct contribution of
banking

sector

to

GDP

is

consistently

(www.dnb.co.in/IndiaTopBanks2011/IndianBankingSector.asp)

more

than

5%.

A further close look at the performance of banking sector with another set
of parameters will give a different story altogether. In the larger interest of
the economy, the performance of banking sector is to seen with rest to its
efficiency

in

terms

of

allocation

of

resources

and

operational

effectiveness. Operational efficiency ensures financial services in a safe,


secure, speedy and cost effective manner. Whereas, allocation efficiency
ensures allocation of resources to most productive activities as per the
developmental needs of the society. It ensures that broader national
interest are met and interest of most vulnerable sections are protected.
Success of a financial system is in ensuring the efficiency in terms of both
of these factors. But the statistics shows that the operational efficiency
what we saw from the statistics seen earlier is at the cost of allocation
efficiency.
Some of the parameters which will give an idea about the allocation
efficiency are as follows.
a) Composition of number of rural branches in the total number of
branches in the country - The percentage of rural braches of the
total number of braches came down from 57.16 in 1994 to 37.18
in2013.
b) Growth of deposit accounts in favour of customers from rural area in
comparison with their urban counter parts When CAGR of deposit
accounts in rural area during 1994 2012 was a meagre 1.4% , the
increase in accounts from Urban area was13.86%. Also the
proportion of deposits from rural areas came down from 15.2% to
9.4%.
c) Proportion of credit availed by rural customers Proportion of credit
flowing to rural areas came down from 18% to 8%.
d) Sectoral Distribution Bank credit to Agricultural and SSI units came
down from 30.03% to 17.95% during 1994 to 2012.
e) Concentration of deposits

It can be seen from the above table that there a definite positive
shift towards bigger cities in terms of both deposits are credits.
f) Shift from individuals to others Percentage of number of accounts
decreased from 96.05% to 85.61 and in terms of amount it
decreased from 77.43% to 50.64% during 1997 to 2012.
Detailed statistics are given at Annexure I. All these statistics (Speech
of Deputy Governor RBI at FIBAC 2013 taken from RBI website) clearly
indicates the attention of banks have been shifting steadily from rural to
urban, agricultural/ SSI Units to bigger corporate entities, individual
customers to business establishments. All these work against the
objective of better allocational efficiency.
Allocational inequalities are also evident from the fragmented
structure of banking sector as can be seen from the chart given below.
Regional Rural Banks and co-operative banks which forms more than 65%
in number contributes only less than 6% in terms of business. This implies
the domination and pivotal role of Scheduled Commercial Banks excluding
RRBs

in

the

Indian

banking

.
( www.dnb.co.in/IndiaTopBanks2011/IndianBankingSector.asp)

sector.

Above observations establishes the need for having some serious action
for improving the allocation efficiency and making the sector more
inclusive in its growth.

3.Brief History of Banking Sector in India


A brief look at the evolution of present day banking network in India
will give better clarity about the course of action to be taken for coming
out of the current problem and ensuring better support of banking system
to the growth of the economy. In pre independence era, initials banks
were set up as joint venture for taking care of the business interest of
British East India company. Subsequently many private banks came up at
different parts of the country and they sated playing an important role in
the economic development of the country. Moreover the banks became
one of biggest. To ensure that the banks are working in synchronization
with the development objectives of the economy, 14 of these largest
banks were nationalized in 1960. Next round of nationalization of 6 more
banks came in 1980. With this Govt. of India ensured that more than 91%
of the banking business is under its control and this situation continued till
1990.( http//en.wikipedia.org/wiki/Banking_in_India)
Post liberalization in early nineties, licenses were issued to 12 private
banks. Out of these only very few which were already having experience
working

in

finance

sector,

having

adequate

financial

resources,

professional and trustworthy manpower could survive and be successful.


Other banks which were started by banking professional could not survive
complexities of this sector and they were merged with other banks or had
to wind up. The experience in small banking sector consisting of Local
Area Banks and co-operative banks was also not very encouraging. These
small banks had the inherent weakness of unviable cost structure.
Moreover, they lacked professional man power due their location
disadvantages. In addition these banks were exposed to higher risks for
the very same reason.(Entry of new banks in the private sector Discussion paper by RBI) .

These experiences gave a clear lesson that the banks will not be able to
survive without a strong financial support and availability of professional
management. As the ownership by business /industrial houses were not
allowed in banking sector due to fear of concentrated control and
possibility of diversion of public money, Govt explored the possibility of
allowing

foreign

banks

to

operate.

To

facilitate

this,

the

equity

participation limits were gradually raised and now it stands at 74%. Govt.
also allowed participation of business/industrial houses in banking sector
in a limited way with sufficient precautions.
In spite of all these initiatives from the Govt. the sector could not
deliver to the expectation of a fast growing economy. This was evident
from some of the statistic seen in section 2 above. This forced Govt. to
look forward seriously to bring in more participation of private entities in
this sector with effective control mechanisms. Ineffectiveness of the
existing banking system in terms of social objectives financial inclusion
and the recent global crisis in the financial sector prompted Govt, to look
structural changes to make the financial systems more robust and
effective.

4.New Initiatives
Based on its past experience in giving licenses and the present
performance of the system, Govt has to take adequate care while deciding
about the next lot of licenses. Some of the important points to be taken
care are.
a) Licences are to be given to those who can effectively spread their
network. This necessitates huge capital investment. In this context,
Govt has to consider seriously about participation of large business
houses, directly or indirectly, with adequate precautions to avoid
centralization of control and consequent possible flow of public
funds for private use.

b) Previous experience in finance sector is a preferred pre-requisite for


maximizing the probability of success of new ventures in Banking
sector.
c) For the above 2 reasons, and considering the huge requirement of
capital, Govt has to seriously think about participation of foreign
banks with adequate controls, but still making it attractive for huge
investments.
d) Ensuring a structure that can deliver desired goals is extremely
important. But there are lots of contradictions in requirements and
approaches and Govt has to make a very difficult and hard choices.
Govt. made its intentions clear through a statement of Finance Minister
in both houses of Parliament The Indian banking system has emerged
unscathed from the crisis. We need to ensure that the banking system
grows in size and sophistication to meet the needs of a modern economy.
Besides, there is a need to extend the geographic coverage of banks and
improve access to banking services. In this context, I am happy to inform
the Honourable Members that the RBI is considering giving some
additional banking licences to private sector players. Non Banking
Financial Companies could also be considered, if they meet the RBIs
eligibility criteria.
Subsequently RBI has come out with a series of consultation papers on
the subject matter, including one on re structuring of the section in Aug
2013, inviting suggestions and opinions from all stake holders. Points
identified for consultation with respect to new licenses to be issued are
a) Minimum capital requirements for new banks and promoters
contribution
b) Minimum and maximum caps on promoter shareholding and other
shareholders
c) Foreign shareholding in the new banks
d) Eligible Promoters
e) Whether industrial and business houses could be allowed to
promote banks
f) Should Non-Banking Financial Companies be allowed conversion into
banks or to promote a bank
g) Business Model

Various alternatives with their pros and cons have been presented by
RBI while calling for suggestions and opinions. Subsequent to these
consultations, a draft proposal has been posted on the website of RBI on
____ calling for final suggestions and proposals from stake holders.
Meanwhile, realizing the necessity for bringing in structural changes in
the banking sector to make all these efforts fruitful, another series of
consultations have been initiated by RBI. Major issues considered for
consultation are
(i) Small banks vs. large banks:

(ii) Universal Banking:


(iii) Continuous authorisation:
(iv) Conversion of UCBs into commercial banks:
(v) Consolidation:
(vi) Presence of Foreign Banks in India:
(vii) Indian banks presence overseas:
(viii) Government Ownership:
(ix) Deposit Insurance and resolution:
Ultimately, Govt. has come out with a 4 layered structure for the
banking sector. Proposed structure is given in Annexure II. As can be
seen, the proposed structure is a blend various options on various issues
under consideration.

5.Conclusion
Acknowledging the fact that a strong and vibrant banking system is
most essential for consistent inclusive development of the economy, Govt
has initiated steps for augmenting the number of banks in operation and
also for restructuring the sector. Govt. has involved in multiple rounds of
consultation to ensure that views of all stake holders are taken care before
a final decision is take. As mentioned earlier, the four layered structure
tries to adopt benefits of operational efficiency of large scale banks and
the effectiveness of small local banks in financial inclusion. But challenge

will be in proper integration of this structure to a single banking system


which will work together for meeting the ultimate requirements of the
economy and citizens of this country. Last but not the least, the political
will of the government in implementing its own decisions.

Annexure I

Annexure II

References
1. www.dnb.co.in/IndiaTopBanks2011/IndianBankingSector.asp

2. http//en.wikipedia.org/wiki/Banking_in_India
3. Entry of new banks in the private sector Discussion paper by RBI
4. Speech of Deputy Governor RBI at FIBAC 2013 taken from RBI
website
5. Speech of Deputy Governor RBI at DFDI London in 2007 taken from
RBI website
6. Banking structure in India The way forward, the discussion paper
of RBI

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