sector reforms have been introduced in a calibrated and well-sequenced manner
since the early 1990s and have resulted in a competitive, healthy and resilient
financial system. There has been financial deepening: the deposits/ GDP ratio
rose from 16.4 per cent in 1971-75 to 36.1 per cent in 1989-90 and further to
60 per cent in 2004-05. Bank credit to commercial sector increased from 15.6 per
cent to 30.3 per cent of GDP in 1989-90 and 48 per cent in 2005-06.
Annual Policy Statement for the year 2007-08 by Governor, Reserve Bank of India
185 states that ' with a view to directing the resources of banks to their
niche areas and to sustain efficiency in the banking system, a graded approach
of licensing may be appropriate which can be equally applicable to both domestic
and foreign banks. A technical paper on this subject will be placed on website
inviting comments/suggestions from the public'
an internal study in RBI covered the background on banking regulation, licensing
of banks under Banking Regulation Act, 1949, extant policy relating to bank licensing,
both Indian and foreign banks international experience and practice on limited
Statutory background- Banking Regulation Act, 1949
to the enactment of Banking Regulation Act, 1949 which aims to consolidate the
law relating to banking and to provide for the nature of transactions which can
be carried on by banks in India, the provisions of law relating to banking companies
formed a part of the general law applicable to companies and were contained in
Part XA of the Indian Companies Act, 1913. These provisions were first introduced
in 1936, and underwent two subsequent modifications, which proved inadequate and
difficult to administer. Moreover, it was recognised that while the primary objective
of company law is to safeguard the interests of the share holder, that of banking
legislation should be the protection of the interests of the depositor. It was
therefore felt that a separate legislation was necessary for regulation of banking
in India. With this objective in view, a Bill to amend the law relating to Banking
Companies was introduced in the Legislative Assembly in November, 1944 and was
passed on 10th March, 1949 as the Banking Companies Act, 1949. By Section 11 of
the Banking Laws (Application to Cooperative Societies) Act, 1965, the nomenclature
was changed to the Banking Regulation Act, 1949.
Indian banking system
Indian financial system currently consists of commercial banks, co-operative banks,
financial institutions and non-banking financial companies ( NBFCs). The commercial
banks can be divided into categories depending on the ownership pattern, viz.
public sector banks, private sector banks, foreign banks. While the State bank
of India and its associates, nationalised banks and Regional Rural Banks are constituted
under respective enactments of the Parliament, the private sector banks are banking
companies as defined in the Banking Regulation Act. The cooperative credit institutions
are broadly classified into urban credit cooperatives and rural credit cooperatives.
Powers and responsibilities of RBI in respect of regulation of banks
Reserve Bank of India has been entrusted with the responsibility under the Banking
Regulation Act, 1949 to regulate and supervise banks' activities in India and
their branches abroad. While the regulatory provisions of this Act prescribe the
policy framework to be followed by banks, the supervisory framework provides the
mechanism to ensure banks' compliance with the policy prescription.
General Framework of Regulation
existing regulatory framework under the Banking Regulations Act 1949 can be categorised
as follows :
Business of Banking Companies
Licensing of banking companies
Control over Management
Acquisition of the Undertakings of banking companies in certain cases
Restructuring and Resolution including winding up operation
Licensing of banks
terms of Sec 22 of the B.R.Act, no company shall carry on banking business in
India, unless it holds a licence issued in that behalf by Reserve Bank and any
such licence may be issued subject to such conditions as the Reserve Bank may
think fit to impose.
Before granting any licence, RBI may require to be satisfied that the following
conditions are fulfilled:
that the company is or will be in a position to pay its present or future depositors
in full as their claims accrue;
that the affairs of the company are not being , or are not likely to be, conducted
in a manner detrimental to the interests of its present or future depositors;
that the general character of the proposed management of the proposed bank will
not be prejudicial to the public interest or the interest of its depositors;
that the company has adequate capital structure and earning prospects;
that having regard to the banking facilities available in the proposed principal
area of operations of the company, the potential scope for expansion of banks
already in existence in the area and other relevant factors the grant of the licence
would not be prejudicial to the operation and consolidation of the banking system
consistent with monetary stability and economic growth;
Business of banking
per Section 5 (b) of Banking Regulation Act, 1949 ' banking ' means the accepting
, for the purpose of lending or investment, of deposits of money from the public,
repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise.
Permissible Activities of a Banking Company
6 of B.R. Act, 1949 gives the details of forms of business in which a banking
company may engage. However, it is a long list and banks may carry out one or
more activities permitted in the section.
Policy of issuing licence to banks in India
policy framework for issuing licences to private sector and foreign banks are
Private sector banks
Licensing of foreign banks
issues a single class of banking licence to banks and hence does not place any
undue restrictions on their operations merely on the ground that in some countries
there are requirements of multiple licences for dealing in local currency and
foreign currencies with different categories of clientele. Banks in India, both
Indian and foreign, enjoy full and equal access to the payments and settlement
systems and are full members of the clearing houses and payments system.
foreign banks are required to apply to RBI for opening their branches in India.
Foreign banks’ application for opening their maiden branch is considered under
the provisions of Sec 22 of the BR Act, 1949. Before granting any licence under
this section, RBI may require to be satisfied that the Government or the law of
the country in which it is incorporated does not discriminate in any way against
banks from India. Other conditions as enumerated in para 2.5 above
are required to be fulfilled.
the restrictive practices of certain foreign countries, India is liberal in respect
of the licensing and operation of the foreign bank branches as illustrated by
the following :
issues a single class of banking licence to foreign banks and does not place any
limitations on their operations. All banks can carry on both retail and wholesale
insurance cover is uniformly available to all foreign banks at a non-discriminatory
rate of premium.
norms for capital adequacy, income recognition and asset classification are by
and large the same. Other prudential norms such as exposure limits are the same
as those applicable to Indian banks.
Opening of branches in India by Foreign banks
policy for approving foreign banks applications to open maiden branch and further
expand their branch presence has been incorporated in the ‘Roadmap
for presence of Foreign banks in India’ indicated in the Press Release dated February
28, 2005 as well as in the liberalized
branch authorisation policy issued on September 8, 2005. The branch authorisation
policy for Indian banks has been made applicable to foreign banks subject to the
banks are required to bring an assigned capital of US $25 million up front at
the time of opening the first branch in India.
foreign banks having only one branch would have to comply with the above requirement
before their request for opening of second branch is considered.
banks may submit their branch expansion plan on an annual basis.
addition to the parameters laid down for Indian banks, the following parameters
would also be considered for foreign banks :
bank’s and its group’s track record of compliance and functioning in the global
markets would be considered. Reports from home country supervisors will be sought,
would be given to even distribution of home countries of foreign banks having
presence in India.
treatment extended to Indian banks in the home country of the applicant foreign
bank would be considered.
consideration would be given to the bilateral and diplomatic relations between
India and the home country.
branch expansion of foreign banks would be considered keeping in view India’s
commitments at World Trade Organisation (WTO). Licences issued for off-site ATMs
installed by foreign banks are not included in the ceiling of 12.
terms of India’s commitment to WTO, as a part of market access, India is committed
to permit opening of 12 branches of foreign banks every year. As against these
commitments, Reserve Bank of India has permitted upto 17- 18 branches in the past.
The Bank follows a liberal policy where the branches are sought to be opened in
unbanked/under-banked areas. Off-site ATMs are not counted in the above limit.
Including off-site ATMs, foreign banks are having ( as on October 15, 2007) place
of business at 933 locations ( 273 branches + 660 off site ATMs).
procedure regarding approval of proposals for opening branches of foreign banks
in India has been simplified and streamlined for the sake of expeditious disposal.
licence under the provisions of B.R. Act, 1949 enables the foreign banks to carry
out any activity which is permissible to a bank in India. This is in contrast
with practices adopted in many countries, where foreign banks can carry out only
a limited menu of activities.
against the requirements of achieving 40 per cent of net bank credit as target
for lending to priority sector in case of domestic banks, it has been made mandatory
for the foreign banks to achieve the minimum target of 32% of net bank credit
for priority sector lending. Within the target of 32%, two subtargets in respect
of advances (a) to small scale sector (minimum of 10%), and (b) exports (minimum
of 12%) have been fixed. The foreign banks are not mandated for targeted credit
in respect of agricultural advances. There is no regulatory prescription in respect
of foreign banks to open branches in rural and semi-urban centres.
Differentiated Bank Licensing- Examining Pros and Cons
Arguments in Favour of Adopting a Differentiated bank Licensing
With the broadening and deepening of financial sector, it is observed that banks
are slowly migrating from a situation in the past where the number of banking
services offered by the banks was limited and all banks provided all the services
to a situation where banks are finding their niche areas and mainly providing
services in their chosen areas. Many banks keep the plain vanilla banking as a
small necessary adjunct. It is widely recognized that banks providing services
to retail customers have different skill sets and risk profiles as compared to
banks which mainly deal with large corporate clients.
present situation where every bank can carry out every activity permissible under
Section 6 of Banking Regulation Act, 1949 has the following implications, relevant
to the subject under consideration :
a wholesale bank dealing with corporate clients only, it becomes a costly adjunct
to maintain a skeleton retail banking presence. Moreover it becomes difficult
for such a bank to meet priority sector obligations and obligations for doing
banks may have to create risk management and regulatory compliance structures
which are more appropriate to wholesale banks, thus resulting in non-optimal use
supervisory resources are devoted to banks with different business profiles. This
may also result in non-optimal use of supervisory resources.
priority sector lending regime for foreign banks indicated in paragarph 3.3 has
been causing some discomfort for some of the foreign banks. For example, some
of the foreign banks find it difficult to fulfil even the less rigorous target
of 32 per cent in respect of priority sector advances.
banks find it difficult to provide ' no frills' facility to economically disadvantaged.
For them the more liberal licensing regime causes a different set of problems.
appears that given an opportunity, some of the banks may like to follow a niche
strategy rather than competing as full service all purpose banks.
On the other hand, there are some factors which point towards desirability of
continuing with the existing system of universal banking:
India, the penetration of banking services is very low. Less than 59 % of adult
population has access to a bank account and less than 14 % of adult population
has a loan account with a with a bank. Under such circumstances, it would be incorrect
to create a regime where banks are allowed to choose a path away from carrying
banking to masses.
sector lending is important for banks. The revised guidelines on priority sector
lending have rationalized the components of priority sector. For the first time,
investments by banks in securitised assets, representing loans to various categories
of priority sector, shall be eligible for classification under respective categories
of priority sector (direct or indirect) depending on the underlying assets, provided
the securitised assets are originated by banks and financial institutions and
fulfil the Reserve Bank of India guidelines on securitisation. This would mean
that the banks' investments in the above categories of securitised assets shall
be eligible for classification under the respective categories of priority sector
only if the securitised advances were eligible to be classified as priority sector
advances before their securitisation. These measures would make it easier to comply
with the priority sector lending requirements by those banks which had faced some
difficulties in this regard.
business model adopted by such ‘niche’ banks depends heavily on ample inter-bank
liquidity. Any shock leading to liquidity crunch can translate into a run on the
bank. This situation has been clearly illustrated recently in UK in the case of
Northern Rock Bank.
International experience and practice
experience and practices of licensing procedure followed in major jurisdictions
by the respective regulators have been studied and we have grouped them into two
viz limited banking licence - equally applicable both for domestic and foreign
banks and limited bank license-different for domestic and foreign banks. In addition,
there are countries where different licences are issued for commercial banking,
savings bank, rural banks or credit unions . In certain counties no distinction
is made between domestic and foreign banks. Thus, there is no widely accepted
recommended model available internationally.
may be seen that one of the major objectives of banking sector reforms has been
to enhance the efficiency and productivity of the banking system through competition.
It is also aim of authorities to provide banking services to maximum number of
people. To enable the banking system to operate at optimum efficiency, and in
the interest of financial inclusion, it is necessary that all banks should offer
certain minimum services to all customers, while they may be allowed sufficient
freedom to function according to their own business models. Thus, it will be prudent
to continue the existing system for the time being. The situation may be reviewed
after a certain degree of success in financial inclusion is achieved and Reserve
Bank is more satisfied with the quality and robustness of the risk management
systems of the entire banking sector.