FUTURE OF

BANKING
INDUSTRY IN
INDIA
RBI may allow 7-8 new
banks
 The Reserve Bank of India (RBI) is likely to give banking licences to seven
eight new entities, including aspirants among nonbanking financial
companies, as well as industrial houses. The number of new licences to be
issued, which would be much higher than what the prospective applicants
had estimated, was arrived at after rounds of discussions with the
government. RBI had said a “few” licences would be given, leading the
market to believe the number would be three or four. According to banking
industry sources, the government, which is keen on financial inclusion
through spreading formal modes of credit to all parts of the country, insisted
that more new players be allowed.

 The process to allow new banks has come from RBI nearly a decade after
two entities were allowed to set up banks in the previous round.

 The central bank had released the final norms on new bank licences. Most
major corporate houses, such as the Tata group, Birla group and Reliance
Industries, besides nonbanking financial companies like L&T Finance, M&M
Financial Services and the Shriram group, are said to be interested in
setting up new banks.
 RBI is also likely to issue clarifications to the aspirants on the ‘fit and
proper’ criteria. In the final norms, RBI had said an entity would be
considered fit to set up banks if it has a track record of sound
credentials and integrity, and has been financially sound over the past
10 years.

 This had raised concern among some aspirants with cases pending
with the Central Bureau of Investigation, Enforcement Directorate,
Income Tax Department, etc, that they would be disqualified from
applying. Some of these aspirants had sought clarification from the
regulator, asking if such pending cases would indeed amount to
disqualification.

 RBI is expected to clarify that such instances would not be a hindrance

in applying for banking licences, provided all such cases are disclosed
fully.
The central bank is expected to make the clarifications public by the
end of the month or early next month. The queries were asked to be
sent and RBI had said it would clarify without disclosing the identity of
the entities seeking those clarifications.
Union Budget 2015-16: Mudra for
microfinance and financial inclusion
growth
 The announcement to create a Micro Units Development
Refinance Agency (Mudra) Bank is a major positive step that
the Finance Minister Arun Jaitley has taken on the
microfinance and financial inclusion space.

 Jaitley said he was proposing to create a Mudra Bank, with a

corpus of Rs 20,000 crore, and credit guarantee corpus of Rs
3,000 crore. Mudra Bank, he said, "will refinance
microfinance institutions through a Pradhan Mantri Mudra
Yojana". In this, he said, priority will be given to SC/ST
enterprises. "Just as we are banking the unbanked, we are
also funding the unfunded,"he said.
 Challenges in the Current
Macroeconomic Environment
 We have come a long way since the difficulties in 2012-13 as a result of actions taken by the
Government and regulators. Growth is stronger, the current account deficit has narrowed
significantly, the fiscal deficit is on a consolidation path, and inflation has halved. However,
three areas are still “work in progress” from RBI’s perspective. First, economic growth is still
below levels that the country is capable of. Second, while consumer price inflation has
moderated, inflation expectations amongst the public are still high, creating a gap between
the real rates that savers expect and the rates corporations think they pay Third, stressed
assets in the financial system continue to be high, which holds back growth and new lending,
even while dampening bank incentives to cut base rates.

 The short term macroeconomic priorities of the Reserve Bank are therefore clear:

• Help growth by bringing down inflation in line with the proposed glide path, thus creating
room for monetary easing; and

• Work with the Government and banks on speeding up the resolution of distressed projects
and cleaning up bank balance sheets.
 Some issues in tackling inflation
 In picking the policy rate path and the pace of deflation, we have to be
mindful that there are multiple players in the economy; consumers and
producers who need to borrow, households that need to save, and banks
that need to do both. Producers love lower interest rate, and they do not
hesitate to tell us. But saving households balk as deposit rates are cut,
especially if rates do not compensate adequately for inflation. The fall in
household financial savings, the increase in gold purchases, and the
widening of the current account deficit in recent years was partly caused by
negative real after tax deposit rates.

 Of course, banks stand partially in between borrowers and lenders, and to

transmit rate reductions they should be able to cut both borrowing as well
as lending rates. Concerns have been expressed about Government small
savings schemes that pay a high rate to households, making banks
reluctant to cut their own deposit rates for fear of being dis-intermediated.
While Government small savings rates should be readjusted more
frequently to market rates, the growth of these schemes is small for the
most part, and at least for now these schemes should not be an inseperable
barrier to transmission .
Responding to the Inflation
 Modern economic theory suggests there is indeed a short
run trade-off between inflation and growth. In layman’s
terms, if the central bank cuts the interest rate by 100
basis points today, and banks pass it on, then demand will
pick up and we could get stronger growth for a while,
especially if economic players are surprised. The stock
market may shoot up for a few days.
 But if the economy is supply constrained, we could quickly
see shortages and a sharp rise in inflation. The central
bank may then be forced to raise interest rates
substantially to offset that temporary growth. The boom
and bust will not be good for the economy, and average
growth may be lower than if the cut had not taken place.
This is why modern economics also says there is no long
run trade-off between growth and inflation – the best way
for a central bank to ensure sustainable growth is to keep
demand close to supply so that inflation is moderate.
Stressed Assets and Speedy
Resolution
 In dealing with stressed bank assets, RBI has been focused
on getting the underlying real project back on track. There
are a number of impediments here. The stigma as well as
the provisioning (and the associated fall in profitability)
attached to a loan being labelled “non-performing” makes
banks eager to avoid the label.
 In some cases, they ignore the reality that existing loans will
have to be written down significantly because of the changed
circumstances since they were sanctioned (which includes
extensive delays, cost overruns, and over optimistic demand
projections). The Debt Recovery Tribunal system has not
been speedy, which also emboldens uncooperative
promoters and keeps them from accepting their share of the
losses.
 Strong Sustainable Growth
for the Indian Economy
 We live in an increasingly uncertain world. Seven years after the financial crisis, advanced
economies are still growing slowly, while a number of emerging economies are experiencing
difficulty as the old export-led growth model flounders. In this environment, there is both
challenge and opportunity. Challenge because the world will not provide the strong and
supportive growth environment we had in the last decade, opportunity because global
capital is looking for investment opportunities.

 As I said late last year in my Bharat Ram lecture entitled “Make in India, Largely for India”, to
implement the Prime Minister’s vision of producing in India at a time when trade across the
world is falling, we will have to strengthen the domestic market so as to absorb much of the
increased production until the global market recovers. This means we have to increase
domestic demand, while avoiding the booms and busts that typically plague such efforts by
emerging markets. My focus in today’s talk will be on what the RBI is doing to help the
Government create the conditions for sustainable growth. Structural reforms will help
strengthen this growth – two weeks ago, the Government announced Indradhanush, last
week we licensed new payment banks, next month we will license new small finance banks,
two new universal banks are starting in October providers of the TREDs system will be
licensed in November, and so on, but these developments are best left to a future speech.
FUTURE LANDSCAPE OF
INDIAN BANKING
 Liberalization and de-regulation process started in 1991-92 has made a
sea change in the banking system. From a totally regulated
environment, we have gradually moved into a market driven
competitive system. Our move towards global benchmarks has been,
by and large, calibrated and regulator driven. The pace of changes
gained momentum in the last few years.

 Globalization would gain greater speed in the coming years particularly

on account of expected opening up of financial services under WTO.
Four trends change the banking industry world over, viz. 1)
Consolidation of players through mergers and acquisitions, 2)
Globalisation of operations, 3) Development of new technology and 4)
Universalisation of banking. With technology acting as a catalyst, we
expect to see great changes in the banking scene in the coming years.
The Committee has attempted to visualize the financial world 5-10
years from now. The picture that emerged is somewhat as discussed
below. It entails emergence of an integrated and diversified financial
system. The move towards universal banking has already begun. This
will gather further momentum bringing non-banking financial institutions
also, into an integrated financial system.
 The competitive environment in the banking sector is likely to result in individual
players working out differentiated strategies based on their strengths and market
niches. For example, some players might emerge as specialists in mortgage
products, credit cards etc. whereas some could choose to concentrate on particular
segments of business system, while outsourcing all other functions.

 Some other banks may concentrate on SME segments or high net worth individuals
by providing specially tailored services beyond traditional banking offerings to satisfy
the needs of customers they understand better than a more generalist competitor.
International trade is an area where India’s presence is expected to show
appreciable increase. Presently, Indian share in the global trade is just about 0.8%.
The long term projections for growth in international trade is placed at an average of
6% per annum.

 With the growth in IT sector and other IT Enabled Services, there is tremendous
potential for business opportunities. Keeping in view the GDP growth forecast under
India Vision 2020, Indian exports can be expected to grow at a sustainable rate of
15% per annum in the period ending with 2010. This again will offer enormous
scope to Banks in India to increase their forex business and international presence.
Globalization would provide opportunities for Indian corporate entities to expand
their business in other countries. Banks in India wanting to increase their
international presence could naturally be expected to follow these corporates and
other trade flows in and out of India.
 Retail lending will receive greater focus. Banks would compete with one
another to provide full range of financial services to this segment.
Banks would use multiple delivery channels to suit the requirements
and tastes of customers. While some customers might value
relationship banking (conventional branch banking), others might prefer
convenience banking (e-banking).

 One of the concerns is quality of bank lending. Most significant

challenge before banks is the maintenance of rigorous credit standards,
especially in an environment of increased competition for new and
existing clients. Experience has shown us that the worst loans are
often made in the best of times. Compensation through trading gains is
not going to support the banks forever. Large-scale efforts are needed
to upgrade skills in credit risk measuring, controlling and monitoring as
also revamp operating procedures. Credit evaluation may have to shift
from cash flow based analysis to “borrower account behaviour”, so that
the state of readiness of Indian banks for Basle II regime improves.
Corporate lending is already undergoing changes. The emphasis in
future would be towards more of fee based services rather than lending
operations. Banks will compete with each other to provide value added
services to their customers.
 Structure and ownership pattern would undergo changes. There would be greater
presence of international players in the Indian financial system. Similarly, some of
the Indian banks would become global players. Government is taking steps to reduce
its holdings in Public sector banks to 33%. However the indications are that their
PSB character may still be retained.

 Mergers and acquisitions would gather momentum as managements will strive to

meet the expectations of stakeholders. This could see the emergence of 4-5 world
class Indian Banks. As Banks seek niche areas, we could see emergence of some
national banks of global scale and a number of regional players.

 Corporate governance in banks and financial institutions would assume greater

importance in the coming years and this will be reflected in the composition of the
Boards of Banks.

 Concept of social lending would undergo a change. Rather than being seen as
directed lending such lending would be business driven. With SME sector expected
to play a greater role in the economy, Banks will give greater overall focus in this
area. Changes could be expected in the delivery channels used for lending to small
borrowers and agriculturalists and unorganized sectors (micro credit). Use of
intermediaries or franchise agents could emerge as means to reduce transaction costs
ACTION POINTS ARISING OUT
OF VISION REPORT
 Banks will have to adopt global standards in capital adequacy, income
recognition and provisioning norms.
 Risk management setup in Banks will need to be strengthened.
Benchmark standards could be evolved.
 Payment and settlement system will have to be strengthened to ensure
transfer of funds on real time basis eliminating risks associated with
transactions and settlement process.
 Regulatory set-up will have to be strengthened, in line with the
requirements of a market-led integrated financial system
 Banks will have to adopt best global practices, systems and
procedures.
 Banks may have to evaluate on an ongoing basis, internally, the need
to effect structural changes in the organisation. This will include
capital restructuring through mergers / acquisitions and other measures
in the best business interests. IBA and NABARD may have to play a
suitable role in this regard.
Conclusion
 Focus on the challenges in ensuring sustainable growth should not
detract from the tremendous progress we have made. There is
much to be optimistic about, including the massive investments
that are starting in infrastructure, the tremendous sweep of
information technology across every facet of Indian life, and the
radical changes that are taking place in the financial sector.

 The Indian economy is full of possibilities, even as much of the

world is mired in pessimism. Indeed, I have been arguing that the
fragility of the world economy is precisely because it has focused
on quick fixes rather than deep reform. A summary of the
Government and the Reserve Bank’s measures to restore
sustainable growth is that we are building the necessary
institutions.