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RBI's Draft Guidelines for Private Sector Banks
RBI has released draft guidelines for licensing new banks in the private sector. The draft guidelines lay down the conditions on which corporate groups will be permitted to set up banks in India.

Eligible Promoters
Both objective and subjective criteria have been laid down to determine the eligibility of promoters to set up a bank. The subjective elements include "diversified ownership, sound credentials and integrity". Curiously, RBI has demonstrated some uneasiness with reference to other businesses that prospective promoters may be carrying on. Here are some extracts:

 

 



Banking is essentially based on fiduciary principles as depositors' money is involved. It therefore becomes imperative that the fit and proper assessment framework for bank promoters is much more comprehensive in scope as compared to other sectors. Any such framework also needs to look into the nature of activities the promoter group of the bank is predominantly engaged in. There are certain activities, such as real estate and capital market activities, in particular broking activities which, apart from being inherently riskier, represent a business model and business culture which are quite misaligned with a banking model. Post-crisis, there are concerted moves even internationally to separate banking from proprietary trading. More importantly, in India, past experience with brokers on the boards of banks has not been satisfactory. It will therefore be necessary to ensure that any entity/ group undertaking such activities on a significant scale is not considered for a bank licence. Otherwise there will be real risks of the same business approach getting transmitted to the banks as well and it will be difficult to address this only through regulations. Accordingly, entities/groups that have significant (10% or more) income or assets or both from/ in such activities, including real estate construction and broking activities taken together in the last three years, shall not be eligible to promote banks.


It is not clear if tainting all players in a specific type of business activity with the same brush is a prudent approach. For example, as these comments observe, stock broking activity is a regulated industry subject to fitness norms and may not deserve the type of blacklisting treated meted out by the RBI.

Corporate Structure
RBI has specified the structure that corporate must be used while setting up banking activity. Promoters must set up a non-operative holding company (NOHC) through which they will hold the bank and all other regulated financial activities within the group. As the draft guidelines note, this is to "ring fence the regulated financial services activities of the group" from other non-financial activities. Depending on existing structures of corporate groups, successful licensee may need to restructure their group holdings to comply with the proposed structure.
 


Minimum Capital
The initial minimum capital requirement is Rs. 500 crores. There are very specific requirements on shareholding limits of the NOHC in the bank. For instance, there is a lock-in of 40% shares of the NOHC in the bank for 5 years. Although the NOHC may start with a higher shareholding, it has to be pared down to 40% within 2 years from the date of licensing, to 20% within 10 years, and to 15% within 12 years. The bank will have to be listed on a stock exchange within 2 years, which is quite a short time frame. Hence, the establishment of the bank as well as its initial business operations must provide for early listing.

Foreign Shareholding
To begin with, a private sector bank can raise only up to 49% from foreign investors. It is only after 5 years that the prevailing policy of foreign investment in banking will become applicable, which is that foreign investment is allowed up to 74%. To that extent, RBI has followed a phased approach for the new private sector banks by not making the general foreign investment policy applicable to them at their initial stage. This would mean that a private bank conducting an IPO in the first 2-year period will have to largely rely on the domestic supply of capital.

 

 



Corporate Governance
The draft guidelines provide some broad indication of the type of governance norms to be followed by private sector banks. The emphasis is on ring fencing all regulated activities under the umbrella of the NOHC. Moreover, the draft guidelines call for a separation of ownership and management in promoter companies that own or control the NOHC. This might be somewhat difficult to comply with, especially in the case of banks to be established by traditional family corporate groups. The only specific governance norm is that "at least 50% of the directors of the NOHC should be totally independent of the promoter / promoter group entities, their business associates, and their customers and suppliers". In that sense, RBI appears less concerned with governance issues at the level of the bank itself, but more with the corporate group establishing it, as these norms extend to both the NOHC as well as the promoters.

The draft guidelines set out several other operational conditions for grant of banking licenses, including priority sector targets, mandate on core banking solutions, and the like. Other conditions include those relating to relationships between the bank and the promoter group entities, and how they are to be regulated.

 


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