Much awaited banking licenses to be issued by RBI to reshape banking sector

The next generation of banking structure will be the first step to a thousand mile journey to make India the third largest banking economy in the world. The issue of "on-tap" new banking licenses will prove to be a game changer for the Indian banking industry.

The Bimal Jalan committee has already completed the process of selecting applicants for issues of new banking licenses expected to be announced by March 31.

Not only will it induce greater competition, but it will also stimulate the Indian banking industry that is lagging behind its global peers.

India indicates huge untapped potential for the banking industry. Banking assets to GDP ratio was recorded at 90 percent consistently for the last five years since 2009. This is low when compared to other developing countries and developed countries that have recorded much higher than 100 percent.
Credit to GDP ratio in India is around 77 percent while banking credit to GDP was recorded at 52 percent. This is low among emerging and advanced economies in Asia that have a credit to GDP ratio of more than 100 percent.

Credit growth in India is recorded between 15 percent and 17 percent for 2013 and is expected to slowdown in 2014. Financial inclusion (every citizen having access to basic banking services) is also low with only 35 percent of the total population having access to banking services.

However, the industry stood strong in terms of capital adequacy, solvency, and profitability measures during and after the financial crisis despite increasing non-performing assets.

The Reserve bank of India (RBI) aims to boost these industry statistics via issuance of new banking licenses, especially financial inclusion statistics. While this step would improve the assets to GDP and credit to GDP ratio, whether financial inclusion would be achieved is debatable.

The RBI has mandated new banks to open 25 percent of their branches in unbanked regions right from the beginning of its inception. Such unbanked regions have not been very attractive for bankers as the low transaction size does not compensate for the costs incurred in such areas.

Sheetal Kothari, Sr. Research Analyst, Business and Financial Services, Frost & Sullivan,said: "If profitable opportunities existed for banks to operate in the current unbanked regions within the existing industry setup, opportunities would have been exploited by the existing players. Hence, new banks can only be successful if they come up with innovative strategies that combine technology and low cost operating models for the banks that can process small ticket size transactions."

Lending in India is unorganized. New banks will also have to explore the untapped opportunity by collaborating with micro finance institutions, to tap the lending potential in these unbanked/under banked regions.

Another challenge is with respect to priority sector lending that is mandated by the RBI for the new banks. Non-performing loans are high in some of these sectors and new banks would have to develop superior underwriting expertise to ensure profitability in lending to such sectors.

Despite these challenges, low financial inclusion in India has opened up the biggest opportunity for new players.

Apart from financial inclusion, another impact of this expansion would include increase in competition, better business models, product innovation, cost efficient structure, greater access to credit, more focus on customer service and decreased industry concentration.

In addition, it will also help the industry to transform market share dynamics. Market share would begin to shift in favor of new banks that offer better products and services from few underperforming public sector banks; there may be a wave of merger and consolidation in the industry.

However, such mergers would bring down the number of players in the industry and the entire exercise may prove to be futile. But, if RBI chooses to issue further licenses after March 31, general or specialized, the industry dynamics are expected to change considerably with emergence of new business models and shift in market statistics to those players who offer better customer service.

The extent to which such a shift may occur would largely depend on the number of banking licenses issued and the companies that have been granted such licenses.

Kothari further opined: "The RBI and Bimal Jalan committee may approve licenses to those companies that are better placed to incorporate financial inclusion into their banking business models and yet emerge strong and profitable in the changing industry structure."

One such applicant can be India Post. Extending postal services to incorporate banking services would be an ideal solution to address financial inclusion due to the extensive outreach of India Post.
Moreover, India Post already has deposit services to add to its financial credentials. Other promising applicants include Bajaj Finance (well placed in terms of small ticket consumer durables financing), Aditya Birla group (rich and successful experience as an NBFC with an insurance arm); Shriram City Union Finance (market leaders in small loans segment in South India) and Edelweiss Financial Services (tie ups with leading financial services companies and a strong management team).

Banking Licenses is a Market Insight, which is part of the Business and Financial Services Growth Partnership Service program. Frost & Sullivan's related studies include Micro, Small and Medium Small Loan Credit Market for Non-Banking Financial Corporations in India, India 2020: Implications for Corporate and Financial Strategies, and Geographic, Technological, and Financial Portfolio Analysis of Top 30 Fastest-growing Automotive Suppliers. All studies included in subscriptions provide detailed market opportunities and industry trends evaluated following extensive interviews with market participants.

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