Old Bank Licences Are Back In Vogue

Until a few years ago, bank licences in India were associated with a scarcity premium. The Reserve Bank of India opened a window to grant such licences periodically and whenever it did, there was a queue of applicants. In the 2013-14 round of bank licencing, 25 entities applied and two—IDFC Ltd. and Bandhan Financial Services— were granted approval.

Soon after though, the RBI started the process of putting new bank licences on tap. A 2013 discussion paper laid the ground work for abandoning the “stop and go” licencing policy and move towards continuous authorisation. In August 2016, we finally got a set of guidelines for on-tap licencing of new banks.

In the two and a half years since then, there has been no new bank licensed under those guidelines. UAE Exchange is the only publicly declared applicant under the new licencing regime but an approval has not yet been granted. In recent months, particularly since the NBFC crisis broke out, banking consultants have spoken of interest from a few senior bankers to apply for bank licences but these applications are yet to be finalised.

In the meantime, there have recently been four deals between non bank financial companies and banks – IndusInd Bank-Bharat Financial Services; IDFC Bank-Capital First; Bandhan Bank-Gruh Finance; and Indiabulls Housing Finance-Lakshmi Vilas Bank.

With the exception of the Bandhan Bank-Gruh Finance deal, the other three, in one way or another, have been linked to the need to access a deposit-taking franchise.

The Case of Indiabulls Housing Finance-Lakshmi Vilas Bank

Consider the deal between Indiabulls Housing Finance and Lakshmi Vilas Bank, announced on Friday. Indiabulls Housing Finance was one of the 25 applicants for a bank licence in 2013 but was denied one when the final list was released in 2014.

The on-tap bank licencing rules say that an entity can’t reapply for a bank licence for a period of three years from the time of rejection. With that period over, Indiabulls Housing Finance, which says it is fully eligible for a bank licence, could have used the on-tap route if it wanted to. Instead it chose a merger with Lakshmi Vilas Bank.

It is about Lakshmi Vilas Bank’s existing network and deposit base? Tough to argue that.

The combined entity will have Rs 30,787 crore in deposits to help fund a loan book of Rs 1.48 lakh crore. Of this, current account and saving accounts deposits, which are most sought after in a bank, are just at Rs 7,036 crore. The bank’s branch count is also modest at 569. As such, the bank’s network and deposit base doesn’t really do much to help Indiabulls Housing Finance.

“Given Lakshmi Vilas Bank’s relatively small scale and weak deposit franchise (23 percent CASA), funding cost benefit in the near term will be limited, requiring significant investments in branches to scale up deposit franchise,” said Credit Suisse in a report on Monday.

“There is no other value for Indiabulls Housing Finance from Lakshmi Vilas Bank other than its banking licence,” said Macquarie Research in its note.

Bank Licence: Old vs New

The process of applying for a new bank licence is an onerous one, as it should be. An application is first vetted by an internal RBI committee and then an external one. Feedback is sought from other regulators and even investigative agencies to establish the ‘fit and proper’ status of the applicant and/or its promoters.

• Specifically, an NBFC looking to apply for a bank licence has to ensure that the entities and its promoters have an unblemished track record.
• If the NBFC is part of a group that has total assets of Rs 5,000 crore or more, then the non-financial part of the business must not be more than 40 percent.
• The bank, if approved, must be set up through a non-operative financial holding company.
• The promoters must hold 40 percent of the paid-up voting equity capital of the bank for five years.
• No entity other than the promoter can hold more than 10 percent in the first five years of operation.
• Individuals, directly or indirectly connected with large industrial houses, can only hold 10 percent in the bank. Such a shareholder cannot have controlling interest or a seat on the board.
• The bank needs to maintain arm’s length relationship with the promoter / promoter group entities and the major suppliers and major customers of these entities.

The list above is not even an exhaustive one.

What needs to be seen is whether the RBI follows as stringent a procedure in approving the merger proposal between Indiabulls Housing Finance-Lakshmi Vilas Bank as it would if the former had made a new bank licence application. And whether it ensures that all conditions attached to new bank licences are also extended to an entity acquiring a bank licence via a scheme of amalgamation.

This is particularly important in the case of an entity perceived to be linked to broader corporate interests.

“Indiabulls-Lakshmi Vilas Bank merger, if approved, will be the first instance of conversion of a corporate house/NBFC to a bank, after RBI's release of guidelines for on-tap licensing of universal banks in FY16. This may be a catalyst for similar transactions with other small private banks, making them potential acquisition targets,” noted Credit Suisse.

In short, the deal, if approved, may signal that old is better than new when it comes to bank licences in India, where the attempt to foster increased competition via an on-tap licencing regime is yet to show results.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.