RBI’s Draft Guidelines for Licensing of new Private Sector Banks in India: a welcome move

In his budget speech in February, 2010, the Union Finance Minister made an announcement with regards to licensing of new private sector banks. Pursuant to this announcement on August 11, 2011, the RBI had put out a discussion paper on its website titled "Entry of New Banks in the Private Sector". Based on the responses received from the non-banking financial institutions, industrial houses, other institutions and the public at large, and after extensive internal discussions and consultation with the Governmentof India, the RBI has come up with the Draft Guidelines on licensing new private sector banks.

It is imperative to note that these Draft Guidelines will be come into force subject to the amendments in the (Indian) Banking Regulation Act, 1949 (the Banking Regulation Act), especially amendments to certain provisions like the removal of restrictions on voting rights, empowering RBI to approve acquisition of shares/voting rights of 5% or more in a bank to persons whom the RBI considers as ‘fit and proper’, vesting the RBI with the authority to supersede the board of directors of the new banks to protect depositors’ interests and facilitating consolidated supervision.

Some of the key features of the Draft Guidelines are:

Eligibility:

Only those private sector groups and entities that are owned and controlled by residents are eligible. Furthermore, under the Draft Guidelines only those promoters/promoter groups that have a diversified ownership, sound credentials, integrity with a successful track record of a minimum of ten years are eligible for securing a bank license. Entities or groups that have 10% or more income from and/ or assets in the real estate construction and broking activities, taken together for the last 3 years are not eligible for availing the license. The RBI is also entitled to consider the nature of activities undertaken by the promoter/ promoter group while granting licenses.

Corporate Structure:

Under the Draft Guidelines the promoter/ promoter groups are required to set-up a Wholly Owned Non-Operative Holding Company (‘NOHC’) to hold its investments in the bank, as well as all other financial services companies that are present within the group and which come within the regulatory purview of the Indian financial services regulators. The objectivebehind doing so is to ensure that the regulated financial services of the group, including banking services are ring-fenced from the commercial, industrial and financial activities not regulated by financial sector regulators. Thus, only those non-financial services companies/entities and individuals belonging to the Promoter Group will be allowed to hold shares in the NOHC. The NOHC is further required to be registered with the RBI as an NBFC for which the RBI will stipulate a separate set of prudential guidelines.  The NOHC is also not allowed to borrow funds for investing in companies held by it.

Minimum Capital Requirements and Holding by the NOHC:

The RBI has mandated that the initial minimum paid-up capital for a new bank will be5 billion (approx. US$ 111.11 million) though the actual capital to be brought in shall depend on the business plan of the promoters.A minimum of 40% of the paid-up capital of the bank is required to be held by the NOHC, with a lock-in period of 5 years from the date of licensing of the bank. Such shareholding is required to be reduced to 20% of the paid-up capital within a period of 10 years, and thereafter to 15% within a period of 12 years, and then it is to be retained at that level.Any shareholding in the new bank by the NOHC in excess of 40% must be reduced to 40% within 2 years from the date of licensing of the bank. The Draft Guidelines further prescribe that in the event the bank raises further capital during the initial 5 years of receiving the license, the NOHC would be required to mandatorily hold 40% of the enhanced capital for a period of 5 years from the date of receiving the license. It is further stipulated that the balance capital of the bank other than those held by the NOHC, can be raised through public issues or private placements.

Foreign Share-holding:

As per the Draft Guidelines the aggregate non-resident shareholding, in the form of foreign direct investment (‘FDI’), foreign institutional investment (‘FII’) and non-resident Indians’ (‘NRI’) investment in new private sector banks shall not exceed 49% of the paid-up capital of the bank for the first 5 years of operations. Individual non-resident share-holding will be restricted to less than 5% of the paid up capital of the bank whether directly, indirectly, individually or as a group. The Draft Guidelines provides that the foreign shareholding should be in accordance with extant policies and so as per the extant policies, the foreign shareholding is to be limited to a maximum of 74% of the paid-up capital in private sector banks at the end of the initial 5 year period.

Corporate Governance:

As per the Draft Guidelines at least 50% of the Board of the NOHC should comprise of directors, independent of the promoter or promoter group entities, their business associates, customers or suppliers. The Draft Guidelinesalso mandates that the No financial services entity under the NOHC will be allowed to engage in any activity that a bank is permitted to undertake departmentally.  All such activities, if any, will have to be moved to the new bank subject to such conditions that the RBI may specify. And the supervision of the NOHC and the bank will be undertaken by RBI on a consolidated basis. The ownership and management should be separate and distinct in the promoter / promoter group entities that own or control the NOHC.The source of the promoters’ equity in the NOHC should be transparent and verifiable.

Business Model:

Under the Draft Guidelines all applicants from the private sector seeking to obtain new bank licenses will be required to forward their business plan for the new banks along with their applications. The business model will have to address how the bank proposes to achieve financial inclusion and such model should be realistic and viable. In case of deviation from the stated business plan after issue of license, the RBI may restrict the bank from further expanding, effecting change in management and may also impose other penal measures as may be necessary. 

Other Conditions:

• No single entity or group of related entities (other than the NOHC) shall have shareholding or control, directly or indirectly, in excess of 10 percent of the paid-up capital of the bank.
• Shareholding of 5 percent or more of the paid-up capital of the bank will require a prior approval of the RBI.
• Shareholding of 5 percent or more of the paid-up capital of the bank will require a prior approval of the RBI.
• The bank must maintain arm’s length relationship with its Promoter Group entities, their business associates, their suppliers and customers.  The exposure of the bank to any entity in the Promoter Group shall not exceed 10% of the paid-up capital and reserves of the bank and the aggregate exposure to the group shall not exceed 20 percent of the paid-up capital and reserves of the bank.  All exposures to Promoter Group entities will need prior approval from the bank’s board of directors.
• In taking a view on whether an entity belongs to a particular Promoter Group or not or whether the entities are linked / related to the Promoter Group, the decision of the RBI will be final.
• The bank shall make full use of modern infrastructural facilities in office equipment, computer, telecommunications etc. in order to provide cost-effective customer service. It should have a high powered Customer Grievances Cell to handle customer complaints.
•  The bank shall get its shares listed on the stock exchanges within two years of licensing.
•  The bank shall be required to maintain a minimum capital adequacy ratio of 12% for a minimum period of 3 years after the commencement of its operations subject to such higher percentage as may be prescribed by RBI from time to time. 
• The bank shall comply with the priority sector lending targets and sub-targets as applicable to other domestic banks, and it shall open at least 25 per cent of its branches in unbanked rural centres (population up to 9,999 as per 2001 census) to avoid over concentration of their branches in metropolitan areas and cities which are already having adequate banking presence.
• The promoters, their group entities, NOHC and the proposed bank shall be subject to the system of consolidated supervision by the RBI.
• The NOHC shall be restrained from establishing any new financial services entity for a period of 3 years from the date of licensing of the bank. General statutory provisions including the Banking Regulation Act and the Reserve Bank of India Act, 1934 amongst others, shall continue to be applicable.
• Promoter / promoter group with an existing NBFC (if considered eligible for a bank licence), would have two options: one is to promote a new bank, in cases where some or all of the NBFC’s activities are not permitted to be undertaken by banks departmentally and transfer such activities undertaken by the NBFC which may be carried out by the bank departmentally to the bank; or the other is to convert the NBFC into a bank where all the activities are permitted to be undertaken by a bank departmentally. For both routes, the promoters shall have to set up a NOHC. In such situations, the RBI may permit the new bank to take over and convert the existing NBFC branches into bank branches for tier 3 to 6 centers. Existing NBFC branches in tier 1 and 2 centres would require prior RBI approval subject to the rules applicable to domestic banks for opening branches in such centres. This is further subject to the requirement of maintaining 25% of the branches in unbanked rural centers.
• For promoter groups having 40% or more assets / income from non-financial business, the Board of Directors of the NOHC should consist of a majority of independent directors. Such banks would also be required to file quarterly returns, certified by statutory auditors, of all exposures including credit facilities extended to entities in the promoter group for amounts in excess of INR 10 million. The Draft Guidelines also mandate a prior approval of RBI to be obtained by such banks for raising paid-up capital beyond INR10 billion for every block of INR 5 billion.

RBI Selection Procedure for Granting Licenses:

The RBI has laid down that the applications will go through several rounds of screening to warrant eligibility i.e. initial screening is to be done by the RBI after which the application will then be referred to a High Level Advisory Committee (‘HLAC’) to be set up by the RBI, comprising of eminent personalities in the banking and financial sector. The HLAC will submit its recommendations to the RBI and the RBI will have the final decision with regards to granting of licenses. The RBI may also exercise its discretion not to grant license to an applicant even if it meets the criteria prescribed in the Draft Guidelines. The RBI will first issue an in-principle approval for setting up the bank.  Such in-principle approval will be valid for one year within which the bank should be set up.

The RBI has clarified that it will be very selective in granting the licenses and only those who conform to the above requirements, who have an impeccable track record, and who are likely to conform to the best international and domestic standards of customer service and efficiency, will be considered for licenses.

General Comments:

The Draft Guidelines is a welcome move as it opens a window of opportunity for businesses to enter the private sector banking industry which was not allowed earlier. With the positive comes the negative as, though the licensing process has been addressed in detail there still remains an element of subjectivity as the RBI has made it very clear that its decision with regards to the granting of license will be final i.e. the RBI reject applications if it deems fit even if they fulfill all the required criteria. Considering that numerous applications can be expected forsecuring the licenses there is a possibility that the problem of lobbying might resurface its ugly head. 

Credit rating major ICRA Limited has termed as potentially challenging the ownership and listing conditions proposed by RBI as part of its draft guidelines for new bank licences as some of the businesses may not be mature for listing on the stock exchanges which may deter some corporate entities applying for banking licences.

ICRA has also opined that the requirement of a separate NOHC along with preventing double leveraging will also ensure better monitoring process and control over the NOHCs and their banking subsidiaries by the RBI.Further, the requirement of a minimum 40% promoter shareholding for the first five years should ensure that the promoter concerned retains significant economic interest in the bank during the crucial start-up phase; also, the compulsory reduction in promoter shareholding over the longer term paves the path for a diversified shareholding. The stricter approval processes, tighter concentration norms and higher disclosure requirements envisaged, in ICRA’s view, could reduce the risk of interconnected lending significantly. At the same time, the requirement of RBI approval for issue of fresh equity should ensure compliance with the various clauses related to ownership.

For further details see ICRA - Draft Guidelines for New Bank Licences:  Watchful Advancement

The biggest hurdle which seems to face the Draft Guidelines is that their implementation is subject to the passing of the Banking Laws (Amendment) Bill, 2011 by the Parliament which has been brought in to make necessary amendments in the Banking Regulation Act, 1949. The Amendment Bill has been pending before the Parliament for a few years now and if it continues to languish and gather dust in the Parliament then the provisions of the Draft Guidelines which have been culled out keeping the Amendment in mind might become redundant or may have to be changed substantially with the change in scenario at that time. [By Kasturika Kaumudi (4th year, NUJS)]