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Bank licence: What it means for the listed parent

July 09, 2013 08:41 IST

Photographs: Toby Melville/Reuters Devangshu Datta

The difference between low-value PSUs and high-value private banks may grow

The Reserve Bank of India's (RBI) requirements for granting new banking licenses are stringent. The applicant must have a capital base of Rs  500 crore, and a diversified share-holding, though the latter will probably be eased for the public sector.

Applicants must have a “successful” track record for 10 years and high net worth. Statutory reserve requirements must be met immediately with 4 per cent of deposits placed with the RBI and a holding of 23 per cent in government bonds from day one. Any new bank will have to commit to open one in four branches in rural areas. Also, within three years, they must meet the target of lending 40 per cent to the priority-sector.

The rural branch requirement is no longer quite as painful as it used to be. Rural India is fast urbanising and growth there may be faster than in metros. But priority sector lending is a drag on profits and a political dole. A large proportion of priority sector loans are write-offs from day one.

The profile of the 26 entities applying for licenses is illuminating. A large number are brokerages, which means they are high-margin, high-risk lenders. If they receive access to low interest retail deposits, they could expand in scale. Some applicants have high exposures to vehicle finance. Another stream is gold-backed financing, which is key for Muthoot Finance, for example.

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Bank licence: What it means for the listed parent

Photographs: Jayanta Dey/Reuters

We have recent evidence of how very risky these revenue streams can be. Margin calls can wipe out brokerages, commercial vehicle loans drop in volume and go sour in cyclical downturns, and gold-backed financing incurs big risks when prices drop.

Existing banks also have fingers in these pies. But their securities trading operations are hived off. Vehicle finance forms a relatively small segment, and so do gold-backed loans. The new entities must also create walls, quite apart from developing commercial banking skills.

Two of the government applicants are surprising. The Indian Posts has an easy task in terms of fulfilling branch network requirements and also a base of low-cost retail deposits. It is wholly government owned. Its net worth is unknown and so is the current portfolio.

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Bank licence: What it means for the listed parent

Photographs: Toru Hanai/Reuters

The Tourism Finance Corporation is also applying from left field. It doesn't meet capital base criteria and appears to have little relevant experience. A third Sarkari player, IFCI, has a poor track record and a large portfolio of sticky assets.

Big industrial groups like Aditya Birla, Tata Sons, Videocon, L&T, and Reliance Capital, will all meet net worth and capital criteria with ease. IDFC and LIC Housing Finance are two other “serious” applicants. All have some experience at specific financial segments.

The RBI has always been extremely cautious. It may sit on applications for an indeterminate period. Most probably, it will grant very few licenses after ruthlessly excluding every applicant that doesn't meet its broad basic criteria. It will have to take a call on the systemic risks involved in licensing brokerages and NBFCs with high-risk models.

What sort of market response will new licenses evoke, as and when granted? As a trader, I'd expect a bounce in the scrips of various listed parents. However, this could be months down the line. So it's something to be noted and filed away but there is no immediate action a trader can take.

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Bank licence: What it means for the listed parent

Photographs: Reuters

The entire banking sector, including new licensees will have to raise huge sums in Tier-I capital over the next four years to meet Basel III norms. That means an expansion of capital base, including equity. In theory, that should reduce valuations.

FPO and debenture issues will be successful only if floated by institutions with good reputations and decent balance sheets. The divide between low-valued PSU banks and high-valued private banks may grow.

The RBI does a fair job in maintaining balance sheet standards. However, it cannot plug political gaps. It doesn't possess complete regulatory control of Cooperatives – most banking sector scams have a Co-op component.

Also, no political formation would be willing to stem priority sector bleeding. Ideally, that requirement should be chucked out, or reduced to say, 25-30 per cent.

The banking sector must also contend with slow growth and record levels of restructured loans and non-performing assets. But if interest rates do decline, and there is growth recovery, the sector could start pulling out of a deep trough.

Again, the private banks should do better overall than the PSUs. However, an arbitrageur should look for opportunities in beaten-down PSU bank stocks. As and when, there's a sector-wide bounce, big PSU banks trading close to 52-week lows will produce serious capital gains.

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