No. 56, March 2014

No. 56
(March 2014):

RBI Under Rajan: Answerable to whom?

New Bank Licences: For Financial Inclusion, or Financial Exclusion?

by a contributor

Applicants for new bank licences will be required to furnish their business plans for the banks along with their applications. The business plan will have to address how the bank proposes to achieve financial inclusion. -- Reserve Bank of India, "Guidelines for Licensing of New Banks in the Private Sector", February 22, 2013.

The Indian banking sector is under the spotlight, as new private sector licences are expected to be issued on an ongoing basis from 2014. It is also highly likely that large industrial houses may be permitted to set up banks, overturning a banking policy that prevailed since the first round of bank nationalization in 1969. According to the RBI, one of the principal purposes of issuing fresh licences is to achieve 'financial inclusion' –  to bring the large numbers of persons without access to banking services into the financial system. The authorities claim that such financial inclusion will help bring about more balanced growth and reduce poverty.

How realistic is it to expect that issuing new private bank licences will increase financial inclusion? The track record of existing new private sector banks gives us an indication of what to expect.

The new private sector banks were set up post-1991, when financial liberalization was introduced with the stated intention of infusing more competition in a sector dominated by the government banks, and of bringing in new technology such as core banking solutions (which transformed customers of a branch of a bank into customers of the bank) and automated teller machines (ATMs ). In the first round of new private sector bank licences, Induslnd Bank, UTI Bank (renamed Axis Bank), HDFC Bank, ICICI Bank, IDBI Bank, Centurion Bank, Times Bank, Global Trust Bank (GTB) and Bank of Punjab were given licences. Later Kotak Bank (2003) and Yes Bank (2004) were given licences. Of the original nine new bank licences, four found it difficult to survive and are no longer in existence as they have been merged; GTB had to be bailed out through a merger with the government majority-owned Oriental Bank of Commerce and Times Bank, Centurion Bank and Bank of Punjab were ultimately merged with HDFC Bank. The remaining new private banks report much higher profitability and superior asset quality than their government counterparts and have a much higher market capitalization (i.e., the current market price of the bank's total share capital) than the government banks, but in asset size and branch network they are much smaller. At present, for instance, HDFC Bank has the highest market capitalization amongst Indian banks -- even higher than the State Bank of lndia (SBI).

Metropolitan concentration
One of the key, albeit largely unacknowledged, reasons for the financial success of the new private sector banks has been their concentration in metropolitan centres (population of 1 million plus). The metropolitan centres have always been more profitable for banks as compared with semi-urban centres (population of 10,000 and above but less than 100,000) and rural centres (population of less than 10,000). Though the bulk of the population of India resides in the latter two categories, profitable business prospects in them have been limited. The aims of bank nationalization in 1969 were to push banks (irrespective of the relative profitability of urban/metropolitan centres) to open branches in rural and semi-urban centres and thus achieve a more balanced development; to increase rural credit; and to remove the control of large business houses over banking.

The period of financial reform since 1991, however, appears to have resulted in the increasing concentration of wealth in the metropolitan centres at the cost of rural and semi-urban centres. As on March 31, 2005 (prior to this date the erstwhile ICICI and IDBI were excluded from Reserve Bank of India banking data), metropolitan centres contributed 49.5 per cent of deposits and 63.1 per cent of credit, which increased to 55.1 per cent of deposits and 65.3 per cent of credit by March 31, 2013. The share of deposits and credit of all non-metropolitan centres — urban, semi-urban and rural – declined in the same period.

Concentration of deposits in metros, particularly top three metros
The strategy of the new private sector banks (NPSBs) has been even more metropolitan-centric than that of other banks. This is visible in the concentration of their deposits in these centres. As of March 31, 2013, the NPSBs' all-India market share of deposits was 13.6 per cent; but in the metropolitan centres, which constitute the bulk of deposits, their market share was 17.8 per cent. Their market share of deposits in other centres was much lower: 12.4 per cent in urban centres, 6.7 per cent in semi-urban centres and only 2.2 per cent in rural centres.

Naturally, metropolitan centres made up a much bigger share of NPSBs' deposits, as compared with the State Bank of India group, the nationalized banks and even the older private sector banks (OPSBs). In March 2013, metropolitan centres contributed 72.2 per cent ofNPSBs' deposits, as compared with 40.5 per cent for the SBI group, 57.8 per cent for the nationalized banks and 42.1 per cent for the OPSB. Rural centres' deposits constituted only 1.6 per cent of NPSBs' overall deposits, against 11.3 per cent for the SBI group and 9.2 per cent for the nationalized banks.

There is further concentration even within the metropolitan centres. NPSBs' deposits are concentrated in the top three metropolitan centres of lndia1 — Mumbai (includes Mumbai and Mumbai suburban), Delhi and Bangalore. For the NPSBs the top three metropolitan centres contributed 58.1 per cent of their deposits, as compared with 20.3 per cent for the SBI group, 35.8 per cent for the nationalized banks and 27.3 per cent for the OPSBs.

Even greater concentration of credit
The concentration is even starker in the case of credit. Metropolises accounted for 81.2 per cent of the credit advanced by NPSBs by March 2013. The contrast with NPSBs' credit to rural India, where the bulk of India's population resides, could not be starker. In March 2013, rural credit accounted for only a negligible 0.7 per cent of NPSBs' total credit, as compared with 9.9 per cent for the SBI group, 8 per cent for the nationalized banks, and 3.5 per cent for the OPSBs. The NPSBs, as a business strategy, have totally neglected rural credit as being commercially unviable.

The extent of concentration is further brought out by looking at the figures for NPSBs' deposits and credit in a sub-division of just one metropolis, i.e., 'Mumbai suburban'. Mumbai suburban (Bandra to Borivali, Kurla to Mulund and Kurla to Trombay) alone accounts for 25.3 per cent of the NPSBs' credit – about 36 times that for the whole of rural India!

Bank branches: Tokenism?
The NPSBs have been in operation for nearly two decades, and for much of this period their focus on the metropolitan centres has been with the regulator's (i.e., RBI's) approval as it has approved the NPSBs' branch concentration in these centres.

As of March 2013, 30 per cent of the NPSB branches are based in metropolitan centres, as compared with SBI group's 17 per cent and the nationalized banks' 20.3 per cent. Rural centres account for only 11.6 per cent of NPSB branches as against SBI group's 34 per cent and the nationalized banks' 32 per cent. Prior to 2012-13, a far lower share of NPSBs’ branches were rural branches (around 8 per cent); in that year, the number increased to over 11 per cent on account of the regulator's belated focus on compelling these banks to open more rural branches.

The RBI might claim that it will now ensure greater inclusion through compelling existing and future NPSBs to open more rural branches. The RBI says that "With a view to enhancing financial inclusion, the conditions [for receiving a bank licence] relating to the branch network are specifically prescribed at 25 percent for unbanked rural centres. Further, this norm has been extended to the existing banks also and they are required to comply with this stipulation while opening new branches."

However, more branches, while necessary, may not amount to financial inclusion. On their own, they can amount instead to a form of tokenism. Private sector banks devote a minimum of resources to their rural and semi-urban branches, and instead concentrate their resources on what they view as profitable areas. Thus, in March 2013, the NPSBs' semi-urban and rural branches, which accounted for 44.2 per cent of their branches all-India, accounted for only 8.5 per cent of their deposits and 4.2 per cent of their credit all-India. Meanwhile, the top six metropolises accounted for only 24.3 per cent of the NPSBs' branches, but accounted for 68.3 per cent of their deposits and 68.7 per cent of their credit. Mumbai suburban, with just 3.4 per cent of the NPSBs’ branches, accounted for 25.3 per cent of their credit all-India.

Dubious claims of inclusion
The above gives a picture of the actual evolution of the NPSBs, and their business strategy of remaining primarily metropolitan banks. This reality should be kept in mind when assessing the government's claim that its objective in issuing new private sector bank licences, probably to select industrial houses, is to promote 'financial inclusion'. The track record of the NPSBs in rural banking and financial inclusion suggests the exact opposite: Their strategy is based on financial exclusion, and is concentrated on the metropolises, and within that on the top three metropolises. Moreover, to the extent that they attract a share of metropolitan bank business away from the public sector banks, they increase the pressure on the profitability of the latter, and make them even more unwilling to increase financial inclusion. Thus the expansion of the NPSBs actually intensifies overall financial exclusion.

It is not surprising that the period since 1991 has seen a drastic reduction in the share of bank credit going to agriculture and small scale industry. After the nationalization of the banks, there was a steady decline in the share of rural credit provided by moneylenders. However, post-1991, that trend reversed and the share of moneylenders began to rise, while that of banks began to decline.

The inroads that Indian banking made into rural India in the 1970s and 1980s were on account of bank nationalization. State ownership permitted banks to expand without giving primacy to profitability over developmental aims. To expect the private sector, which undertakes investment for profit, to pursue a strategy of financial inclusion is unrealistic. The authorities' claimed objective of 'financial inclusion' appears merely an excuse to issue new bank licences to select private sector entities.

[Data in the above piece is from Reserve Bank of India, Quarterly Statistics on Deposits and Credit.]




1.In financial terms; population-wise, Kolkata is larger than Bangalore.. (back)



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