The finance ministry has circulated a proposal that aims to ask state-run banks to exit noncore businesses, notably insurance, to force greater capital efficiency and ensure that periodic capital infusion into them goes into increasing the spread of banking rather than propping up money-losing ventures.

The money provided through recapitalisation support is for core banking activities such as increased lending and branch expansion. Banks with interests in other areas may divert the funds, which is not desirable, a senior finance ministry official told ET.

The proposal, which is in the early stages of debate and discussion within the ministry, reasons that noncore businesses such as insurance are highly capital intensive and can take up to 10 years to be profitable.
Indias life insurance industry posted a combined net loss of Rs 4,878.49 crore in 2008-09 , up 43% from a year ago. Of 22 life insurers, only four have reported profits, data from insurance regulator Irda shows.

SBI Life, the first private life insurer to report profit, slipped into the red with a net loss of Rs 26.31 crore in 2008-09 . ICICI Prudential, the largest private sector life insurer has reported losses for the eighth consecutive year, underlining the large gestation period of the business.

An insurance venture needs a minimum startup capital of Rs 100 crore and has solvency margins of 1.5% of the total sum assured. Life insurance companies put in nearly Rs 6,000 crore into their ventures in 2008-09 , while non-life companies brought in Rs 6,228 crore.

Other businesses such as mutual funds and brokerage services also consume a lot of resources and specially smaller banks will not be able to sustain them in a long run, the official said, requesting anonymity.

Besides, the thinking behind the proposal is that insurance and other areas already have plenty of private sector players and does not particularly benefit from the presence of these state-run entities. Banking is the business why they were set up or nationalised. There are already so many private players in other financial services businesses, the official said.

The ministrys changed thinking comes at a time the universal banking or the financial supermarket model that has defined global banking groups such as Citi or the Royal Bank of Scotland for years has been severely tested.

But officials at state-run banks say pulling the plug on their non-bank ventures would be damaging.Not only would it be a financial suicide, but it would also would dent the countrys image as there are a number of joint ventures with foreign partners , said an official with Allahabad Bank, who asked not to be named.

Allahabad Bank is a partner in general insurance venture Universal Sompo General Insurance along with Indian Overseas Bank and Karnataka Bank. More than half a dozen banks have insurance joint ventures, many of them with international companies.

The government has already committed to provide Rs 16,500 crore in capital support to state-run banks in 2010-11 to be complaint with capital adequacy norms. It estimates that state-run banks will need another Rs 38,000 crore in capital over the next two years.

The government stake in many banks is close to 51%. Such banks are not in a position to raise capital from other sources as government stake cannot fall below the 51% threshold. The government has to, therefore, keep pumping in capital to support these banks. The government recently introduced a legislation to lower the minimum stake it needs to hold in SBI to 51% from 55% to give the countrys largest bank greater headroom to raise capital from other sources.