The Reserve Bank of India favours stringent eligibility conditions for allowing new private banks, once again laying bare its deep unease at the prospect of allowing industrial houses into the banking business.

The banking regulator, which plans to approve a limited number of banking licences in line with the announcement in this years Budget by finance minister Pranab Mukherjee, has outlined a few policy approaches, or options, which if translated into rules may make it difficult for many big business houses to promote banks. In a discussion paper on the entry of new private banks released on Wednesday, RBI has said that one option could be to allow only those industrial groups which have a diversified ownership base and without any direct or indirect exposure to real estate. If some of the other suggestions too such as the need for corporate houses to obtain a clean chit from agencies such as the Central Bureau of Investigation, the Enforcement Directorate, income tax and other regulators, denial of the business groups brand name and logo for the new banks brand and a board packed with independent directors are endorsed later, very few large business groups may make the cut.

The paper, which invites comments till September end, also says that it is important for the government to put in place enabling legislations to empower RBI to supercede the boards of private banks if the regulator feels that the bank is not functioning in the interest of depositors or financial stability. RBI last issued banking licences to YES Bank and Kotak Mahindra Bank well over seven years ago after it opened up banking to the private sector in 1994 during Manmohan Singhs tenure as finance minister. Since then, a few expert committees, including one headed by former RBI deputy governor SS Tarapore and advisor to the Prime Minister Raghuram Rajan, had made out a case for allowing industrial houses to promote banks.

Govt keen on private role in banking

The government has also indicated that it favours this approach as it may not be keen on infusing more money into a business which calls for a huge dose of capital. It is keen on opening up banking to the private sector to extend the geographic coverage of banks and to improve access to banking services. The RBI has also acknowledged that a larger number of banks would foster greater competition, reduce costs, improve services and promote financial inclusion.

The discussion paper appears to be weighing in favour of non-banking finance companies converting themselves into banks. One advantage of allowing this would be that NBFCs are already regulated by RBI, which makes the due diligence process easier to handle. Besides, given the success of these entities in expanding the reach of the financial system, this model could be scaled up to achieve the benefits of financial inclusion. The 37-page report discusses five main areas with the pros and cons of various possible proposals without choosing or favouring any one. These are: minimum capital requirements and promoter contribution; cap on promoter holding; foreign holding; permitting industrial houses and financing companies to become banks and the business model. Allowing industrial houses to foray into banking dominates the discussion with one option being to allow them to acquire regional rural banks, or RRBs, as an intermediate step.

The paper says there is abundant evidence, domestic and global, that banks run by industrial houses may not be in the best interests of depositors and the nation, says a non-committal RBI in the discussion paper. The experience of RBI over these 17 years has been that banks promoted by individuals, though banking professionals, either failed or merged with other banks or had muted growth. Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands, says the paper.

NBFCs are upbeat after going through the first draft. According to GS Sundararajan, MD, Shriram Capital, the suggestions are positive. Allowing shareholding up to 20% will give the bank an identifiable promoter who can then get the credit or blame for the banks performance, he said. The Rs 40,000-crore Shriram Group was well placed in terms of the suggestions as it already has a presence in smaller towns, he said.

The draft proposals are close to what we are already doing, said Sachindra Nath, COO, Religare Enterprises. He said Religare Enterprises was modelling its business with an eye on foraying into banking. Besides its track record in financial services, the company was the only one where the principal sponsors restricted themselves to being shareholders and have even stepped down from the companys board.

State-owned infrastructure finance company Power Finance Corporation, which has also shown interest in acquiring a banking licence, said it is in the process of appointing consultants and will decide accordingly. There can be changes in the final guidelines, our consultants will appraise the whole process based on which well take a decision, said a senior PFC official.

In the financial sector, leading NBFCs such as Shriram, Cholamandalam, Sundaram, Religare, Edelweiss and state-owned entities such as Power Finance Corporation, LIC Housing Finance, Exim Bank and SIDBI are keen on acquiring banking licences. Among corporates, both the Tatas and the Aditya Birla Group, which have a presence in financial services, have in the past expressed interest in getting a toehold in this sector. Senior officials in these groups were not available for comment.

Interestingly, two of the leading NBFCs from the South Sundaram Finance, a part of the TVS Group, and Cholamandalam Investment & Finance Company categorically ruled out entering the banking sector on Wednesday. Cholamandalam is, however, considering a proposal to create a middle-level financial intermediary (on the lines of the system in Hong Kong) between full-fledged commercial banks and NBFCs.

RBI is seeking to nudge corporates into taking over some of the weaker links in the banking system the regional rural banks and strengthening them and extending financial inclusion in rural areas. Reserve Bank of Indias proposal attempts to address two issues with one stroke. On the one hand, it is addressing the issue of struggling regional rural banks and of financial inclusion. At the same time, it is giving an opportunity for corporates to get into banking, said Viren H Mehta, director, Ernst & Young, India.

The paper suggests that the minimum capital requirement should be substantially higher than Rs 300 crore for the new set of banks, factoring in the inflation of the last decade and the regions smaller neighbours steep requirements. The central bank has also listed a whole lot of advantages in having a minimum capital of Rs 1,000 crore.

The other big change that the regulator has signalled is the move to limit foreign investment at 50%. The discussion papers says that since the objective is to have strong domestic entities and a diversified banking sector, foreign investment could be capped at a suitable level below 50% and locked at that level for the initial 10 years. The suggestion that foreign direct investment in banks be capped at 50% would put the new entrants in a disadvantage position vis-a-vis incumbents who have higher foreign shareholding. The cap may not be necessary considering that threshold for shareholders at 5% of capital is being retained, said Mr Mehta. The final process of selection of promoters of the new banks could take as long as a year with an external committee expected to finalise the list of eligible candidates.

In 1994, RBIs board of directors approved the list of new private banks but during the next stage it chose to be guided by the recommendations of an external committee headed by former RBI governor IG Patel.