Indian Banking Sector to Release New Guidelines on Banking Licenses

May 30, 2014 Posted by India Briefing Reading Time: 3 minutes

DELHI – Yesterday, Financial Services Secretary for the Reserve Bank of India (RBI) GS Sandhu made a presentation to the new Minister of Finance Arun Jaitley to inform him about the challenges and opportunities facing India’s banking sector. According to The Economic Times, the RBI said that it would introduce a new set of guidelines for differentiated banks and invite applications for banking licences in about four months.

The RBI recently granted banking licences to IDFC (a large infrastructure finance group) and Bandhan Financial Services (a small microfinance group) from a pool of 25 applicants after an almost decade-long hiatus.

Over the past several years, India’s banking sector has suffered from mounting problems of bad loans and a lack of competitiveness in public sector banks that shoulder government debt.

To keep pace with the demand for capital investment from various industries and development projects, especially infrastructure, the RBI has made clear the need to reform India’s banking sector and reduce government intervention.

The RBI’s reason for issuing new banking licenses partly stems from the belief that easier entry will increase competition within the Indian banking sector, thereby making it stronger vis-à-vis other financing sources.

The new set of guidelines is expected to be more inclusive in the sense that more firms will be able to obtain banking licenses restricted to certain geographical regions or banking products.

Differentiating between types of banking licences may allow the banking sector to better serve local needs. These differentiated banks may also become more capable of penetrating into undeveloped rural regions of India that are often underserviced – more than half of the country does not have access to banking services. Therefore, the RBI is encouraging firms that failed to obtain a banking licence previously to re-apply under the new guidelines.

Furthermore, the new set of guidelines may also include the RBI’s policy on payment banks – banks that take deposits, and provide payment and remittances services, but are constrained to investing funds in government securities.

Based on the Governor of RBI Raghuram Rajan’s speech at the Annual Day Lecture of the Competition Commission of India, the RBI has also been considering the viability of implementing payment banks. The outgoing Governor of RBI KC Chakrabarty is concerned that the very low profitability of payment banks may not attract firms to manage them. On the other hand, if there are enough payment banks to hold government securities, then the RBI can lower the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) to capitalize banks. Payment banks can also be implemented in underserviced regions where commercials banks are not incentivized to operate.

The Minister of Home Affairs Rajnath Singh has also advocated for financial inclusion, urging the increased usage of the country’s banking system. While it is clear that both the newly elected Modi administration and the RBI are aiming to introduce pro-business policies, speculators and foreign investors will have the opportunity to see just how deeply the Indian government is willing to reform its banking sector when new guidelines on banking licenses are released in four months.

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