NEW BANKING LICENSEES

HOW WILL THEY CHANGE

THE LANDSCAPE?

A CRISIL Young Thought Leader

2013 Dissertation

Aditi Khanna (PGDBM 2013-15)

XLRI, Jamshedpur

Table of Contents

S. No.

Particular

Executive Summary

Banking Sector: Current Trends and

Outlook

Need for New Bank Licenses :

Financial Inclusion

New Bank Licenses: Challenges for

Applicants

Impact on the Landscape

Conclusion

Page

Executive Summary

The banking sector in India assumes immense importance as it houses the lions share of all
financial assets of the economy. Its health and condition therefore assume immense importance
to the smooth functioning and continued growth of the country. The recent trends in this
industry have not been encouraging, with slowing deposit and advances creation and a growth in
restructured and non-performing assets. Rating agencies do not paint a rosy picture of the near
future either, suggesting a further depression in the sector, with NPAs set to peak around 2015.
The need for new bank licenses in India hinges on its poor score on the front of financial
inclusion, with only one in seven Indians having access to bank credit.
There has however been significant reduction in the number of applicants in this round of
licenses due to the stringent nature of guidelines issued by the RBI this time round, with special
focus on rural penetration and financial inclusion. The indication to give out more frequent ontap licenses has also dissuaded many applicants from making a foray into the industry at this
juncture.
Its focus on the need for financial inclusion notwithstanding, the historical data regarding the
fraction of applications that receive approval does not suggest that a large number of new
licenses will be disbursed. A highly probable scenario is the approval of 2-4 new banks. All the
future impacts on the sector must then be judged while keeping this fact in mind.
The foremost impact on the industry would be that of enhanced competition. It is likely to
affect the industry by way of pushing deposit rates up and pulling loan rates down, leading to
financial innovation as each player tries to appeal to more and more customers and increased use
of technology as each player tries to cut operating costs. The costs of financial innovation and
also increased spend on technology coupled with perpetual upward pressure on deposit rates and
simultaneous downward pressure on the loan rates would adversely affect the margins of the
players. Each of these effects however has both advantages and disadvantages for the different
stakeholders of the system, as have been elaborated upon in the report. The other impacts would
be the development of a good rural banking network as well as some issues that could crop up
regarding corporate governance of new conglomerate-owned banks.
Having said all this however, the general sentiment in the industry, especially among the private
players about the decision and its repercussions is not one of alarm or even serious concern. The
public sector banks however are likely to be slightly wary as they will be the first ones standing
in the line of fire due to the increased competition.

Banking Sector: Current Trends and Outlook 2014

Banks make up the vasculature of the Indian economy, cornering 63% of the total assets of the
financial sector. Their condition and health therefore assume prime importance for the country,
especially as it has been undergoing a
slowdown for the past year.
Aggregate Deposits Annual Growth Rate
In the ongoing financial year (FY-14), the 20.0
banking sector has seen some bad times. While 18.0
the growth rate of aggregate deposits 16.0
plummeted, credit growth too slumped as the 14.0
Reserve Bank hiked policy rates to curtail 12.0
10.0
inflation.1
Sept '12 Dec '12 Mar '13 Jun '13 Sept '13
During the same time, the profitability
All India
Rural
Semi-urban
potential of the banks took a hit as their asset
quality deteriorated and NPAs hit a new high
of 3.42% of gross advances (1.7% of net
NPAs (% of Gross Advances)
advances). According to the RBI, an increase
was recorded in the total stressed assets of the 4.00
3.42
2.94
2.45
banking system (NPAs plus restructured 2.00
2.36
2.51
2.39
assets), which led to an increased risk
exposure of the sector, as shown by the rising 0.00
2008 2009 2010 2011 2012 2013
Banking Stability Indicator figure of the RBI.
Stressed Assets could peak at about 15% in
FY15.2
Going forward in 2014, most rating agencies
have indicated a negative outlook for the
industry due to the burgeoning of loan loss
reserves, especially in the public sector banks
due to their financing of hefty iron and steel
and infrastructure projects. They are likely to
be increasingly dependent on government
injections to maintain their capitalization
levels, according to a Moodys Report.
1

http://www.business-standard.com/article/finance/credit-growth-slumps-on-rise-in-lending-rates113112700881_1.html
2
Fitch 2014

Other factors likely to have an adverse impact on profitability are the stringent application of
Basel III norms and revised Priority
Credit vs Deposits of Scheduled Commetcial
Sector Lending (PSL) rules.
Banks
Aggravating the bad news is an
1500
ASSOCHAM report that predicts a
1000
further increase in the NPAs in 2014
due to a lag effect on asset quality in
500
relation to the state of the economy".3
0
Further, inflation concerns and a
2005 2006 2007 2008 2009 2010 2011 2012 2013
sluggish GDP growth point towards a
Credit Demand (Rs. mn)
Deposit Creation(Rs. mn)
slowing credit growth rate.4

Need for New Bank Licenses: Financial Inclusion

The prime motive of reopening the window for
licenses by the RBI was to achieve financial
inclusion. The inclusion targets come from three
broad policy stances:

Coveragemonitored by number of nofrills accounts and other such products

Outreachbranches in different categories
of habitation, and
Deploymentpriority sector, agriculture
and weaker sections 5

CRISIL Inclusix Score

50
40

37.6

40.1

42.8

35.4

2009

2010

2011

2012

30
20
10
0

The need for the inclusion focus comes from the fact that India is home to the worlds largest
unbanked population. Just 1 in 2 Indians have a savings account and 1 in 7 Indians have access
to bank credit. CRISILs financial inclusion index called Inclusix (which measures financial
inclusion on three parameters: branch penetration, deposit penetration and credit penetration)
recorded an all India score of 42.8 on a scale of 100 (2012) which, although reflecting a healthy
upward trend, points towards an under penetration of formal banking. Wide disparities in access

ASSOCHAM Report: http://articles.economictimes.indiatimes.com/2013-12-31/news/45739683_1_assetquality-gross-npas-40-listed-banks

4
Indiainfoline 2014: http://www.indiainfoline.com/Markets/News/Banking-Outlook-2014-Dun-andBradstreet/5839002708
5
http://www.livemint.com/Industry/bGJ4YBT2GraAIJxW1DaT3H/New-bank-licences-the-meaning-ofinclusion.html

Parameter
India
to financial services were recorded as
Bank Branches per 1000 km
30.43
well. While Indias six largest cities
ATMs per 1000 km
25.43
were found to have 10% of all bank
10.64
branches, the bottom 50 districts Bank Branches per 100000 people
ATMs per 100000 people
8.9
merely have 2%.6
Bank Deposits to GDP (%)
68.43%
This is confirmed an IMF study from
Bank Deposits to Total Credit (%)
51.75%
2011 which finds India way short of
Source: IMF Survey 2011
its next door neighbor in this regard.
The objective of the policy therefore, is spot on.

China
1428.98
2975.05
23.81
49.56
433.96%
287.89%

New Bank Licenses: Challenges for Applicants

In the past, RBI has been seen to be keen on doling out new bank licenses only once every
decade. In each of the two previous occasions in 1993 and 2004, over 100 applications were
filed. This time however, only 26 applications came forward initially, out of which one (Tata
Sons) was subsequently withdrawn. Clearly, the amalgam of economic downturn coupled with
much more stringent RBI guidelines hasnt gone down well with the Indian corporate sector.
Following could be the possible deterrents:

6
7

Dilution of Equity: Progressive reduction of shareholding of promoter NOFHC is

envisaged to restrict it to 40% for the initial 5 year period, to eventually 15% within 12
years.
Rural branches: 25% of all branches to be opened in rural unbanked areas from the very
beginning.

Priority Sector Lending Rules: At least 40% credit to be extended to Priority Sector,
which has been redefined to exclude certain SME advances .

Ambiguous Fit and Proper Criterion: A financially strong and successful

performance of past 10 years is a prerequisite.

Basel III Requirements: The timing of the new banks to go public may coincide - if new
banks commence operations within the next two years - with the bulk of the additional
Basel III core capital requirements, which are largely back-loaded for the Indian banking
system.7 This would be the time when existing banks will also be looking to the markets
to beef up equity, making life tough for the new entrant banks.

The indication by the central bank to give out more frequent on tap licenses in future.

http://crisil.com/pdf/corporate/CRISIL-Inclusix.pdf
https://www.fitchratings.com/gws/en/fitchwire/fitchwirearticle/High-Barriers-to?pr_id=785052

Impact on the Landscape

How many licenses are really likely?

New Banks: Applications vs Licences

The impact new banks have on the existing

Awarded
structure will depend significantly on the
number of banks that actually end up making
113
100+
the cut. The past data is not very encouraging.
In the first phase of private entities getting
licenses, 9 out of 113 applicants qualified. In
9
2
the second phase in 2004, 2 from a pool of
over a 100 applicants were christened as
1993
2004
banks. With the emphasis on the objective of
financial inclusion this time round however, speculation is rife that a good number of licenses
may be doled out this year. The finance minister has been recorded as saying that there is no
ceiling on the exact number8, and that each application will be judged on its merit. Newspapers
however have quoted an unnamed but well-placed source as indicating There is a thinking that
at least three new bank licenses would be given out one to a corporate house, second to a nonbanking financial company and a third one to a microfinance company 9. With their eyes on the
more frequent on tap licenses moreover, this round of license disbursal may not result in a
significant number of permits.
Thus a low likelihood of a significant number of new entrants into the sector has been
established. The most probable scenario thus looks like the sector will see 2-4 large payers
entering the fray. Having said that, following may be the changes that these might bring:

Enhanced Competition
The first and foremost impact would be on the incumbent players in the market as the new
entrants will fight for a share of the same pie, which is growing, albeit slowly. It is likely to
affect the industry by way of pushing deposit rates up and pulling loan rates down, leading to
financial innovation as each player tries to appeal to more and more customers and increased use
of technology as each player tries to cut operating costs. The costs of financial innovation and
also increased spend on technology coupled with perpetual upward pressure on deposit rates and
8

http://www.thehindu.com/business/Industry/no-ceiling-on-number-of-new-bank-licenceschidambaram/article4872797.ece
9
http://indianexpress.com/article/business/banking-and-finance/rbi-likely-to-give-banking-licences-ontap-basis/

simultaneous downward pressure on the loan rates would adversely affect the margins of the
players. Each of these effects however has both advantages and disadvantages for the different
stakeholders of the system.

Possible Impact of Increased Competition

Effect

Positive Impact

Negative Impact

Higher Deposit and

Lower Loan Rates

Deposit and Credit Growth

Excess Liquidity in the System and

Further Stress on Asset Quality

Financial Innovation

Enhanced Customer Satisfaction

Regulatory Costs and Potential for

Increased Volatility

Increased Use of
Technology

Cheaper, Faster Customer Service

Security and Privacy Concerns

Lower Margins for

Banks

Fewer 'Too Big to Fail' Banks

More M&A Probabilities

Higher Deposit and Lower Loan Rates

(+) Deposit and Credit Growth
Banks, in a bid for securing the same customers, would be compelled to be highly competitive on
the front of deposit and loans rates, jacking up the former and lowering the latter to maintain and
grow their market share. This would encourage credit growth as cost of capital for both the
wholesale and retail customer decreases, and is also likely to have a positive impact on the
slowing rate of deposit growth in the economy.
(-) Excess Liquidity in the System and Further Stress on Asset Quality

As has often been seen, especially in the US and certain Eurozone countries, one of the subtle
underlying causes of financial crises has been the excess liquidity in the economy due to the
abundant availability of cheap credit. Lower interest rates may lead to this drawback. Further, it
is possible that in an effort to expand consumer base, banks create more credit than they can
chew, and not always with the best of customers. With already rising NPAs and deteriorating
asset quality of existing banks, the sectors efforts to move away from riskier avenues could be
partially thwarted as banks have the innate need to secure a minimum number of customers and a
minimum amount of business.

Financial Innovation
(+) Enhanced Customer Satisfaction and Growth
This is likely to lead to more satisfied consumers as they are likely to receive a greater level of
customization and personalization in banking service delivery. A study in this field has found
that a higher level of financial innovation is associated with a stronger relationship between a
countrys growth opportunities and capital and GDP per capita growth.10 It would also widen the
net for banks as they are likely to be able to cater to a wider pool of customers, who now would
have some products that would solve their problems - products that were found missing earlier.
(-) Regulatory Costs and Potential for Increased Volatility
The same study however has also revealed that a higher level of financial innovation is
associated with higher growth volatility among industries that rely more on external financing
and depend more on R&D activity and with higher bank fragility. The central bank however has
throughout taken a firm stand on the limits of innovation that it would allow in the financial
domain. With newer engineering techniques in the fray, the regulator is likely to have a tough
time overseeing the stability of the system, which would lead to increased need for higher
regulatory costs.
Increased Use of Technology
Cheaper, Faster Customer Service
The increased usage of technology by the banks, intended at lowering operating costs and
streamlining bulky processes is likely to lead to cheaper and faster service delivery to consumers,
with lower lead times and greater efficiency. With digitalized account opening procedures
already making headway, such technological forays are also likely to make rural banking
profitable as the banks can now reach the populace more easily and in a cost effective manner.
Increased Risk of Sabotage
Increased dependence on technology, especially for confidential information relating to identity
and finances of people appears risky in terms of security and privacy of data. A lot of effort need
to go into mitigating security concerns as theft of such sensitive data could come with dangerous
consequences.

10

http://www.tcd.ie/Economics/assets/pdf/Bank_Financial_Innovation_Jan30_12.pdf

Lower Margins for Banks

Fewer 'Too Big to Fail' Banks
As the banks get squeezed from both ends due to increased bargaining power of the consumer,
wholesale and retail alike, the margins and RoE of the banks stand to lose value. Particularly hit
will be the Public Sector Banks as they are already capital constrained, especially in the wake of
Basel III norms. They stand to take the biggest hit in terms of market share in this scenario. The
positive outcome of this would be the absence of banks that are termed too big to fail referring
to the cascading effect they could potentially have on the entire system due to their sheer size in
the event of a financial crisis.
More M&A Probabilities
Walking on thin margins and low profitability would also make certain banks attractive
acquisition targets. With the RBI not having made any specific comment about the necessity of
organic growth for the new entrants, there could be the realistic possibility of these new players
engaging in inorganic expansion to meet the stringent requirements.

Rural Banking Network

The RBI guidelines for new bank licenses explicitly contains a clause for the opening of 25% of
all new bank branches to be opened in rural unbanked areas. Presently, rural branches have
declined to 37% of total branches from 54% in 1994. Rural deposits constitute just 9.1% of bank
deposits, down from 15.1%.11 With the advent of the direct cash transfer scheme launched by the
government of India, there is increased requirement of more branches to open up in rural India
for the successful transmission of its proposed benefit. The new banks, being mandated towards
this objective, upon entry will expand the rural network of bank branches, enabling better
coverage of the rural Indian landscape.

Corporate Governance Issues

The corporate houses had not been granted licenses in the earlier licensing windows based on the
suspicions regarding the corporate governance issues, as these conglomerates having other
businesses with finance dealings would face a situation of conflict of interest. This time,
however, the RBI has taken basic steps to create a ring fence around a licensees bank and other
financial businesses by way of creating the Non-Operating Financial Holding Company
(NOFHC), concerns over the same remain. These have been articulated by the parliamentary
11

http://www.livemint.com/Industry/ZXasKQDiNw7aHazLjVKvcJ/Rural-areas-continue-to-be-ignored-bybanks-RBI.html

panel as well in their report on the matter. The central bank therefore will have to keep a vigilant
eye on the new licensees to ensure the undertaking of ethical practices.

Conclusion
Having said all this however, the general sentiment in the industry, especially among the private
players about the decision and its repercussions is not one of alarm or even serious concern. In
the words of DBS CEO Mr. Sanjiv Bhasin, the new entrants are unlikely to make a material
difference because of the growing nature of the sector, as well as the fact that they would take
substantial time to set up, raise capital, get people, systems and a strategy in place, by when
there would be an even bigger market.12 The public sector banks however are likely to be slightly
wary as they will be the first ones standing in the line of fire due to the increased competition.
A healthy competitive banking sector that caters to all segments of the society and is deep and
liquid enough to ensure efficient flow of capital to not just the most profitable ventures but also
those in need of it is the need of the hour. It is of utmost importance to ensure that India achieves
the coveted spot of one of the strongest and robust economies of the world.

12

http://www.thehindubusinessline.com/industry-and-economy/banking/new-bank-licences-unlikely-tomake-material-difference/article4147329.ece