India needs more banks, and RBI must wake up

The Reserve Bank of India (RBI) recently announced its decision that it was not awarding Small Finance Bank (SFB) licences to the two applicants. The news may appear normal fare but deserves wider attention.

While it is prudent for the banking regulator to be highly careful while awarding bank licences, the process of awarding and rejecting applications is not very transparent. There is a need to focus on streamlining the application process for bank licences and ensure there is vibrant competition in the banking system.

The process of licencing banks in India has followed a stop-go approach where there is suddenly a burst of activity followed by a long lull — and this cycle continues.

One of the planks of the 1991 economic reforms was to open up banking to new private entities. Accordingly, the RBI licenced 10 new banks in 1993. The experiences with new banks were mixed as some did exceptionally well, whereas others collapsed or merged with other entities. In 2002, the RBI again opened the process, and based on its experience with new banks, licenced just two banks. The RBI also experimented with new types of banks — Local Area Banks (LABs) that could operate only in specified regions and serve the financially excluded population and sectors. The RBI awarded licences to 10 banks but just four LABs remained functional.

In 2013, the RBI decided to open a new round for issuing bank licences and received 26 applications. It instituted a high-powered committee to evaluate the applications, and in 2014 awarded licences to just two banks.

In 2014, the banking regulator came up with two new types of banks: Small Finance Banks (SFBs) and Payment Banks (PBs). Like the Labs, the purpose of the DFBs was to promote financial inclusion, but unlike the LABs it did not have any regional constraints. The PBs were designed to provide payments/remittance services to migrant labour workforce, low-income households, small businesses, other unorganised sector entities, among other users. The RBI received 72 applications for the SFBs and 41 for the PBs. It instituted separate committees to vet the applicants, and in 2015 awarded 10 licences for the SFBs and 11 for the PBs.

These new banking licences were a breath of fresh air. In a matter of one year, the banking regulator had given 23 new bank licences.

To further the cause of liberalising bank licences, the RBI announced that licences for universal banks and the SFBs would be available ‘on tap’. ‘On Tap’ means that the licencing window shall be always open, unlike earlier times when it opened sporadically. The applicants could apply as and when they thought that they fit the RBI’s application criteria. Accordingly, the ‘on tap’ licences for universal banks started in 2016 and for the SFBs in 2019. To fast-track applications, the RBI constituted a Standing External Advisory Committee for evaluating applications for Universal Banks and the SFBs.

All these developments gave the impression that the RBI was going to award licences quickly—but that was not to be. Since 2016, only five have applied for universal banks, of which four were rejected. Since 2019, eight banks have applied for the SFBs of which seven were rejected.

While the regulator should be prudent in awarding the licences, its statement of non-acceptance is as parse as it can get. All it says is the applicants were ‘not found suitable’. One could give a slightly more detailed advisory on the parameters for rejection. One also needs to look at the time taken by the special committee to approve applications as in some cases it has taken more than two years. The special committee was constituted in March 2021 for three years. Its term has lapsed, but we are yet to hear of an extension or the constitution of a new committee.

Having said that, the RBI allowed two SFBs to be established via the non-licence route. The regulator permitted co-operative banks to transition to SFBs and one co-operative bank agreed to become an SFB. The regulator also allowed a troubled urban co-operative bank to become an SFB. The idea of PBs did not take-off and of the 11 licences, only six started functioning.

New banks need to open and serve the unbanked population, but one has not seen much progress in the last decade (2013-2023). The total number of banks (excluding co-operative banks and foreign banks) has barely increased from 51 to 53. Payment banks are also not scheduled commercial banks and if we exclude them, the number of scheduled commercial banks is 47, lower than the 2013 figure. While the RBI gave 25 new bank licences, the number of public sector banks declined from 27 to 12 due to the megamerger of public sector banks. Clearly, the regulator needs to encourage more suitable candidates to apply for the bank licences and duly award them as well.

(Amol Agrawal is an economist teaching at Ahmedabad University)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.