Last Friday, we received a major announcement from the Reserve Bank of India. A report from its Internal Working Group (IWG) has suggested major changes to our banking sector. One of the key suggestions was that Non-Banking Financial Companies (NBFCs) could be converted into banks through a ‘guarded entry’. These recommendations would definitely change the structure and functioning of India’s banking sector. Let us understand the specific inputs from the panel report that was released on 20th November.
Details of the Report
The RBI had constituted an internal working group on June 12, 2020. They were assigned the task of reviewing the ownership guidelines and corporate structure for Indian private sector banks. The IWG was chaired by RBI central board director PK Mohanty. On 20 November, the group proposed a series of significant changes. Let us look at some of these:
- The cap on promoters’ stake in private sector banks in the long run (over 15 years) may be increased from 15% to 26% of the paid-up voting equity share capital. This would help to strengthen the institutional framework of banks by ensuring better promoter responsibility.
- On non-promoter shareholding, the panel has suggested a uniform cap of 15% of the paid-up voting equity share capital of the bank may be prescribed for all types of shareholders.
- Very importantly, large corporates and industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulation Act of 1949.
- The group has also proposed a hike in minimum capital for new banks from Rs 500 crore to Rs 1,000 crore. For small finance banks, the minimum initial capital requirement may be changed from Rs 200 crore to Rs 300 crore.
- Payments Banks need to have a track record of 3 years of experience in order to be converted to a Small Finance Bank. Some major examples of Payments Banks are Paytm Payments Bank, Airtel Payments Bank, and Jio Payments Bank.
- Small Finance Banks (SFBs) and Payments Banks may be listed within six years from the date of reaching net worth equivalent to the current entry capital requirement prescribed for universal banks. Or, they may be listed within 10 years from the date of commencement of operations.
- It has been recommended that large NBFCs could be converted into banks. However, this will be done in a strict and guarded manner. A non-banking financial company (NBFC) is a financial institution that does not have a full banking license. It is also not supervised by any national or international banking regulatory agency. As per the report, NBFCs will be eligible for conversion into banks only if they meet two main criteria:
- Well-run NBFCs, including those owned by large corporate houses, should complete 10 years of operations.
- They must have an asset size of Rs 50,000 crore and above.
- Non-Operative Financial Holding Company (NOFHC) can remain as the preferred structure for issuing universal bank licenses. However, it should be mandatory only if the promoter or promoter group owns the other group entities. The NOFHC structure was formed by the RBI in 2013. Under it, any entity or groups in the private sector, public sector, and Non-Banking Financial Companies (NBFCs) can set up a bank – in the form of a wholly-owned NOFHC.
- Banks licensed before 2013 may move to a NOFHC structure at their discretion, once the structure attains a tax-neutral status. Banks currently under the NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold.
The High Growth of NBFCs
Let us take a look at how NBFCs have performed over the last decade. Between 31 March 2009 and 31 March 2019, the total assets of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6%. During the same period, the same value for India’s commercial banks grew at a rate of 10.7%. In absolute terms, the asset size of the NBFC sector (including housing finance companies), as of 31 March 2020, is Rs 51 lakh crore. Hence, the RBI has given more attention to the NBFC segment after analysing its high growth rate for the last 10 years.
Various financial analysts have stated that this move by RBI to convert NBFCs into full-fledged banks is a step in the right direction.
“The move creates scope for large retail-oriented NBFCs with sound financial backing to become banks in order to expand their businesses further by taking deposits and increasing their number of branches” – Dhananjay Sinha, Systematix Group.
Do bear in mind that the report only contains possible recommendations or inputs from the internal working group. The RBI can either accept or reject these inputs. It has been stated that the suggestions would bring uniformity and relaxations in the licensing guidelines of banks. It has been reported that the promotor’s of banks such as Induslnd Bank would benefit if the 26% cap increase is introduced. At the same time, this report may be favourable for large NBFCs. We could see companies such as Bajaj Finance, Mahindra & Mahindra Financial, L&T Finance, and Aditya Birla Capital being converted to full-fledged banks. Do keep a close watch on these stocks.
As we know, the banking sector is the backbone of all economies. Any changes made to this sector will cause a deep impact on the overall functioning of our country. Strong institutions which provide credit are very essential to provide support to India’s growth. There is no doubt that these recommendations can only be implemented through precise planning and execution. Let us look forward to seeing if the RBI will make these changes over the next year. Let us also look forward to seeing more well-performing NBFCs enter into India’s banking sector.