November 27, 2012

finance minister's furore over new bank licenses issue

India's finance minister, Chidambaram, is raising a furore over RBI's stance over the issue of new bank licenses. He wants RBI to initiate the process of inviting applications for new bank licenses right away. He is a great hurry and I suspect it comes from the pressure on the Manmohan Singh-Chidambaram-others gang of economist-extremists by the Indian corporate/industrialists lobby who wants to enter the banking industry without a strict legal oversight on the process.

RBI, which had come recently up with new draft guidelines for allowing news banks to set up shop, states it can initiate the process only after pending amendments to a key banking legislation is approved by the parliament of India. These amendments, it feels, are crucial for it to arm itself with updated powers to deal with new banks under the new guidelines.

Chidambaram claims existing regulations of RBI are sufficient for RBI to initiate the process and that the amendments are only formalising the powers. But he is silent (to the extent I have read up on his statements in news reports) abut what these existing regulations. Even if he were right then one would still question why the need to formalise the powers ever arose, and if the need to formalise the powers is a strong need then why should RBI simply bypass it.

Here is also an editorial on this matter that I contributed for the newspaper I work for presently (it provides more background info on the matter):

Patience is needed

It is not RBI's fault that banking laws amendment bill is still not passed

If a statutory financial regulator is expected to initiate a critical process of allowing new types of entrants in its regulatory domain without the necessary legal regulatory and enforcement powers given by the parliament of the country, there it is hard not to find such an expectation unreasonable and rashly impatient.

This is exactly what is happening with the crticial issue of allowing new entrants in the banking domain which falls under the regulatory domain of Reserve Bank of India. RBI is almost ready with its final guidelines for new banking licenses but need the necessary strengthening of its regulatory powers to deal with the new types of entrants which will allowed as per its proposed guidelines. Large and small corporate groups, who were till know specifically prohibited from promoting new banks, will be allowed as per RBI's draft new guidelines for new banking licenses.

But RBI, in its wisdom, believes that vital amendments to the Banking Regulation Act (1949) are needed before it issues the final guidelines for new banking licenses and invites applications for setting up of new banks. This stance of RBI is known to one and all for over a year and so are the details of the vital amendments it wants. These amendments to Banking Regulation Act are among the various clauses of The Banking Laws (Amendment) Bill, 2011 which is still under consideration by the two houses of the parliament and yet to be approved through a vote.

The vital amendments include, in RBI's own words, the removal of restriction of voting rights and concurrently empowering RBI to approve acquisition of shares or voting rights of 5% or more in a bank to persons who are ‘fit and proper’; empowering RBI to supersede the board of directors of a bank so as to protect depositors’ interest; and facilitating consolidated supervision.

But the finance minister has in recent weeks been telling the RBI not to wait for the parliamentary clearance since the sought-after vital amendments are directly or indirectly already present in existing other laws and RBI's own norms. He thinks that the BL(A) Bill will only formalise these further and emphatically.

The RBI governor, on the other hand, as recently as October 30, in a post-policy conference call for media, stated in response to a question on this matter that legislative amendments will give RBI the necessary authority, power, and dispensation to deal with corporates entering the banking sector. When asked whether the three amendments he wanted for RBI's empowerment applied only to corporate applicants and not for non-banking financial companies wanting to convert into banks the RBI governor was rather firm in stating that RBI's position was that it was best to open up the process for all potential applicants at the same time.

Ten new private-sector new banks were allowed from RBI's 1993 revised guidelines and only 2 from its 2001 revised guidelines. Clearly, there is a case for competition in the banking sector with the entry of new banks. This is particularly so for depositors in the banking system Take the case of savings account interest rate; the only banks who are offering 2-3 per cent more than the banking industry-prevalent 4 per cent are the two who came in after the 2001 guidelines. It is, therefore, no one's case that process should get delayed.

But without the parliamentary clearance RBI may be vulnerable to legal suits and challenges from rejected new applicants who may really pose a risk to a fragile banking system. Putting pressure on RBI now is therefore premature. Let the parliament be convinced of the changes being made and pass the pending bill first. Putting pressure on RBI thereafter will not be unfair.

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