No free lunches in Indian banking

Wed, 10 Mar Pre-Open

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In a country of a billion people, where only 4 out of 10 individuals have a bank account, banking is certainly a very lucrative business. Not only this, the cost of funds (low cost deposits) is less than half the cheapest lending rate. However, given the conservative nature of the RBI, very few non banking companies in India are allowed to raise public deposits. As per the central bank, only 336 out of 12,740 non banking companies in India raise public deposits. Thus, the Budget proposal to allow bank licenses to NBFCs came as a windfall gain to the latter. Investors too rewarded them with share prices of select NBFCs seeing nearly 10% escalation in a week.

What seems to have been forgotten is the intent behind the bank license move. As also the cost attached to the same. The Finance Ministry's intention, as stated in the Budget , is to broaden the geographical reach of India's banking sector. Also additional bank licenses will bring with them the prudential norms that the new entrants will find rather difficult to follow. These include maintaining cash reserve ratio (CRR, reserve with the RBI) at 5.75% of deposits and statutory liquidity ratio (SLR, investment in GSecs) at 25% of deposits. Although NBFCs mostly access costlier short-term funds at expensive rates through commercial papers, the compliance with banking norms will not be very easy either. For instance it took IDBI Bank a good 4 years to comply with these norms after converting itself into a full-fledged bank. Notwithstanding its NPA legacy, the bank is yet to show a respectable NIM (net interest margin).

For the NBFCs, the proposition has several other drawbacks. As non-banking entities, they do not have to write off bad loans until they are 180 days overdue, compared with 90 days for banks. To open a new branch, they only have to inform the RBI while banks have to apply to it for every new branch license.

Further, the RBI is concerned about the ownership structure of privately held banks. The central bank mandates that no single entity can hold more than 10% of a bank. A steep hurdle, given that a majority of the listed NBFCs in India are owned by industrial conglomerates or have large controlling shareholders. Plus, the biggest motive for the RBI is to encourage rural banking. A company applying for banking license will have to sell a convincing case of its commitment to service the lowest strata of the society.

Companies like Future Capital Holdings whose stock has jumped 17% amid the speculation of receiving a banking license may lure investors to cash in on the short term gains. But all that we can say here is caveat emptor - buyer beware! While the possibility of the company receiving a banking license cannot be ruled out, there is certainly no assurance of higher profitability.