With less than 2,000 banks with deposit-taking permissions serving a population of 1.3 billion people, India has far too few banks to cater to its needs. While there is a need to build the periphery through non-bank money transfer and lending services providers, there is also a need to build strong banking institutions that can offer basic services such as retail deposit-taking universally and, as we wait for bond markets to pick up the slack, the ability to finance the corporate sector and the much-needed infrastructure sector.
Principally driven by the enormous ‘depositor penalty’ that is imposed by the larger banks, which translates into ‘low-cost-deposit’ benefit of almost 4 per cent per year on the savings and current-account components of the deposit base of a bank, there is a keen interest in obtaining the full-service banking licenses (including those for small-finance banks) that are on offer. There is, however, also an urgent need to densify the banking landscape by granting a series of differentiated banking licenses under a unified regulatory regime, which will ensure that a wider-range of ‘fit-and-proper’ participants with distinct capabilities enter the market. This will allow rapid movement towards the goals of universal access to finance, while simultaneously continuing to enhance systemic stability.
Payment bank licenses
The Reserve Bank of India (RBI) began this journey by granting some retail payments banks licenses to business entities and corporate houses with large retail footprints that could potentially run all their retail activities in a co-mingled and co-located manner. They would thus benefit from shared costs, but the risk of self-dealing (i.e., lending to their own businesses and consumers) would be avoided because the permission to lend was withheld from these banks. The permission to co-mingle was designed to overcome the business challenges of viability that stand-alone Business Correspondents faced, and to benefit from the vast networks of cash-in-cash-out points and existing business flows that, for example, mobile companies already had in the form of their SIM-recharge points. Payments banks had permissions that non-bank savings facilities providers (such as Prepaid Instrument Providers or PPIs) did not have, which is that they could return financial value (in the form of cash or through a transfer to other accounts) to their customers without falling afoul of the Banking Regulation Act.
Under Section 5 of this Act, “accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise” would require a banking license. It also addressed the added concern that as financial flows, out of savings facilities, became large (as they have in many parts of the world) from a systemic stability point of view, the regulator would need to both observe their flows more directly, and regulate them more carefully. This would be to avoid systemic instability in the event any of these PPIs or the banks that they relied on, experienced a shock of the type seen most recently in India with Yes Bank and the PhonePe wallet.
While the retail payments bank license continues to offer a transition path to the PPIs, there is an opportunity to complete this journey by offering wholesale payments banks licenses to clearinghouses such as NSE Clearing and The Clearing Corporation of India Limited (CCIL). This will allow them to instantaneously clear the money leg of their trades, and give the RBI added oversight over them as well as the opportunity to extend Lender-Of-Last-Resort (LOLR) support to them when needed. As transactions clear in real-time on both the money and the securities legs, the need for credit-guarantee functions would also fall, thus allowing the entire trading system to become more efficient, less costly, and more stable. Euroclear Bank in the EU and the Clear Bank in the UK are examples of such wholesale payments banks that perform these much-needed functions in global markets.
Addressing the financing gap
On the lending side, there are several gaps in the Indian landscape that need to be urgently addressed. At the long end of the market with the departure of the erstwhile Development Finance Institutions (DFIs) like IFCI, IDBI, and ICICI, there is a large financing gap with an impact on project finance and infrastructure finance. As the experience of the erstwhile DFIs has shown and the government’s budget announcement in February 2021 to set up a government-backed DFI has indicated, these are highly specialised businesses that are more comparable to what is referred to as investment banking, and are not well suited to be integrated with retail banking.
India is one of the few regulatory regimes that, for example, require foreign banks seeking to set up shop domestically to take insured deposits from the day they begin operations. Most regulatory regimes do not permit this to banks until they have shown an adequate track record. The grant of a Wholesale Investment Bank license would explicitly fill this financing gap without having to be given access to retail deposits. These banks would instead rely on the full spectrum of wholesale, local, and global sources for building their liabilities and take on only corporate and infrastructure projects on their asset books. The subsidiaries of international investment banks that are currently operative in India could be well-suited for such a license, as would be existing Non-Bank Finance Companies (NBFCs), including those owned by corporate houses that wish to work only in the wholesale markets. By bringing large infrastructure-financing companies under the fold of a banking license, RBI will allow them access to its payments and settlements systems, to the ability to offer wholesale demand deposits, and to its LOLR facilities.
Additionally, many corporate entities successfully run large NBFCs and Housing Finance Companies (HFCs). Many of them, as in the case of retail payments banks, bring core business capabilities in the form of distribution infrastructure and specialised knowledge, through their real-sector businesses, of asset classes such as housing, motor vehicles, and agriculture, that is essential for success in any such business. In a systemic sense, they also help in correctly identifying enterprises that need to be supported with debt, and in pricing the debt appropriately. Allowing such entities to obtain a Wholesale Consumer Bank license, which allows them to access only wholesale deposits but permits them to lend to retail customers if they wish to, is a powerful way to harness their innate capabilities for the greater good without having to worry about self-dealing issues. This also offers a pathway to the regulator to proceed to convert NBFCs and HFCs that have crossed a threshold of, say, Rs 50,000 crore, where their failure could have a strong contagion effect, into regulated banks with all of the attendant safeguards that come with such a license.
Building banking entities for India
From a regulation and supervision point of view, while each of these differentiated banks has some restrictions on what they are permitted to do, it would be important to regulate them as if they were all identical full-service banks, using a unified risk-based-capital-adequacy framework, and not to create multiple regulatory regimes which are then open to internal regulatory arbitrage. This would also reduce the pressure on the supervision capacity of the RBI. The most sophisticated and intensive regulatory scrutiny should be reserved for those banking entities accessing retail deposits and within them, those that are large enough to have significant contagion risk upon failure. Currently, all bank licenses in India necessarily have been conceptualised to access retail deposits, even though this is not required under the Banking Regulation Act’s definition of ‘banking’ in Section 5(b). This has made the availability of lenders with specialised capabilities, the availability of fit and proper promoters with deep pockets, as well as the supervisory capacity of the regulator, face significant bottlenecks to having many such entities who can take their fiduciary duties towards their retail depositor seriously.
India urgently needs a range of entities to cater to the vast diversity in its credit intermediation requirements, including infrastructure financing. Switching off access to retail deposits while also providing LOLR facilities can, as a policy lever when applied alongside a unified risk-based-capital-adequacy framework, serve us well in prudently building these entities.
Nachiket Mor is a former banker and has served on the Board of Directors of The Reserve Bank of India. Deepti George is the Deputy Executive Director & Head of Strategy at Dvara Research. Views are personal.
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