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RBI Internal Working Group Bats for Bank Licenses to NBFCs, Large Corporate Houses

Nov 24, 2020 11:36 AM 3 min read

On the Friday just gone internal working group setup by the Reserve Bank of India (RBI) back in June proposed a series of reforms that if implemented could fundamentally alter the banking landscape of the country.

The suggestions (link to report) would require amending the Banking Regulation Act, 1949 to permit, for the first time:

  1. Large Non-Banking Finance Companies (NBFCs) and payment banks to convert into banks.
  2. Large non-financial corporates to become bank promoters and own significant stakes in banking institutions.
  3. Higher caps on promoter shareholding of banks (from 15% to 26%).
  4. Higher initial capital requirements to license new banks (from ₹500cr ($67.3m) to ₹1,000cr ($134.7m) for universal banks; from ₹200cr ($27m) to ₹300cr ($40.4m) for small finance banks).  

The working group’s report is now open for comments until January 15th 2021.


Banking on Corporates

Corporate-backed or corporate-acquired NBFCs with more than ₹50,000cr ($6.75bn) of assets and a track record of over 10 years may now be eligible for getting a banking license.

Should the recommendations be accepted, India Inc. Could mark its first major foray into banking, something it's been pushing for since forever. But why?

Simple. A banking license means the ability to collect deposits i.e. The cheapest source of funding out there. It means the ability to lend and charge interest. It means the ability to collect a nice margin on money itself. Who wouldn’t want that, right?

According to HDFC Securities, six large NBFCs - Bajaj Finance, L&T Finance, Muthoot Finance, Cholamandalam, Mahindra and Mahindra Finance and Aditya Birla Capital - are likely to apply for banking licenses. But considering the entry criteria, only Bajaj Finance and Cholamandalam Finance may be able to get through.

To segregate and avoid conflicts of interest between corporate and banking, the working group insists that any bank promoter’s non-financial business must not be greater than 40% of his assets or income. Critics however fear that creative accounting and structures may easily bypass that.

So one shouldn’t get surprised if the Adanis or Reliance also join the party. Adani’s bid timing to go after DHFL now looks even more interesting. But we digress...


Old Reform, New Package?

To be fair, the opportunity to acquire an “on-tap license” has been available to NBFCs since 2016. The rationale for on-tap licensing was similar to the one given on Friday: “to boost liquidity, increase competition and bring in new ideas and players.”

But the response has been tepid in the four years since due to high entry barriers and general aversion of the regulator to co-opt the NBFC model.

Indiabulls Housing’s recently failed bid to acquire Laxmi Vilas Bank and latter’s banking license via a backdoor is a pertinent example.


The Buck Stops with the RBI

Also, not all NBFCs may be excited at the prospect of being regulated like banks - even if they are eligible in the first place. Caps on promoter shareholding, minimum requirements regarding Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), and generally more regulatory oversight may be difficult pills to swallow for business houses accustomed to flexibility in operations.

It looks like the RBI...for all its talk of expanding the financial distinctly aware of the schism between a tightly regulated scheduled commercial bank and a comparatively light touch NBFC, and is reluctant to mix the two.

And ironically for the same reason, many NBFCs would rather forgo a lower cost of funding than come under the regulator’s strict capital regime.

Therefore, there is some sense behind the working group’s argument for easing the first-level entry filters and encouraging NBFCs to become banks and to “reduce chances of regulatory arbitrage”.

All of this is still conjecture. The working group’s report is still open for comments, its suggestions could be tweaked by the RBI, or even entirely discarded altogether. A better picture of what lies ahead for Indian banking could be before us once the Central Bank responds to the report and comments early next year.


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