Banking on Maturing Regulatory Landscape

If financial sector regulatory framework is the measure of a nation’s maturity, India is certainly on the path to join the ranks of a mature economy.

The banking sector is arguably a mirror to the economy. Similarly, the regulatory framework for the financial sector could reflect the mood and maturity of the country. The history of banking in India demonstrates this aptly as one walks through the possibly three phases of its evolution.
 
The first phase would be the nationalisation of banks between 1969 and 1980. This resulted in about 80 per cent of the banking activity being owned by the government. It was a period where the country trusted state ownership over regulatory prowess and was possibly the need of the hour at that time. The Narasimhan Committee Report of 1991 launched the second phase that saw 10 new private sector banks being licensed; the first time since independence. This was followed by the committee’s second report and two additional private sector banks were licensed. This period is synonymous with the opening up of the Indian economy and moving from the FERA to the FEMA regime. Although the banking change was not as dramatic, it still was a significant leap of faith for that time.  
 
But the last 15 years have been the most interesting. While only two licences have been granted (IDFC Bank and Bandhan Bank), this period witnessed the birth of the non-operating financial holding company (NOFHC) under which various banking and non-banking businesses of a banking group are required to be housed. Further, the RBI has also boldly introduced differentiated banking licences through Small Finance Banks and Payments Banks, a move which was initially only talked about within regulatory circles, but thankfully saw the light of day in 2015.
 
In August 2016, the RBI moved private sector bank licences on tap doing away with the process of releasing a few licences every decade, which was a relic of the last century. These moves combined with the move to adopt Basel norms in a phased manner for capital adequacy purposes, firmly put the Indian banking sector on a course that brings it on par with global standards.  Furthermore, while introducing these changes, the regulator appeared more receptive to public opinion. Public views on its policies were sought, clarifications provided and certain amendments made. The most impressive change though could be acknowledging the need for adapting the NOFHC guidelines by relaxing them for the differentiated banks and allowing non-promoter shareholding even in Universal Banks, going forward.
 
Lastly, the concept of consolidated supervision of a banking group to cover banking and non-banking financial businesses was fully implemented with the formalising of the consolidated supervision guidelines.  
 
Its time now to look forward to what the new phase ought to bring. A key demand today appears to be that public sector banks be privatised and the industry be solely governed by regulatory action and not banks driven by government. While privatisation of the public sector banks will remain a decidedly political decision, could it be argued that the move to fund Rs 2.11 lakh crore of the approximately Rs 4.22 lakh crore that these banks needed, is a step in the right direction, while leaving the gap to be filled by the banks themselves? Undoubtedly more is needed and hopefully some guidance could be forthcoming in Budget 2018.  Directionally, any discussion on a banking sector consolidation plan to reduce the number of public sector banks would be welcome.  
 
Bank balance sheets need to be cleaned. The relentless drive by the RBI, including pushing banks to take corporates to the Tribunal under the Insolvency and Bankruptcy Code is clearly the most significant effort in the bank balance sheet clean-up that the India has ever seen. While the regulations are now in place and the process appears to be moving ahead at least materially as intended, the Finance Minister should ensure that the tax laws are facilitative and not restrictive.  
 
There is an immediate need to carve-out exemptions to resolutions through the Tribunal from applicability of MAT, enable losses to be carried over where restructuring is necessary, allow tax free transfer or issuance of shares at prices below fair value and also provide some tax litigation protection to buyers for some time to get a grip on the companies that they step in to revive as information on core operations and accounts may not be fully available to buyers immediately.
 
With consolidation and bank clean-up, there is a need to find more capital. Even the capital committed by the government ought to be better deployed. While various announcements to this effect have been made over the year, a policy statement setting out clear performance parameters on the lines of how market analysts and investors view banks, as being the basis to receive any capital, would firmly align the interests of the government and investors and ideally should encourage private capital along with government funding.
 
Competition could be fostered by levelling the playing field between Indian and foreign banks, allowing the former access to products such as acquisition financing and the latter to possibly branch expansion. Further, NBFCs are now regulated almost like banks, but tax laws are not aligned. Interest on NPAs should certainly not be taxable in line with accounting rules and withholding provisions ought to be relaxed to avoid cash being trapped in taxes payments.
 
Lastly, with consolidated supervision of banking groups to cover non-bank financial services as well, the government and RBI must find a way to enable seamless flow of information, products and services within this group and take away the need for multiple forms, multiple KYCs, acknowledging that services are provided by the group together and not separately.  
 
The penultimate year of this government could be a good time to set the foundation for the next decade of banking reforms where “new banks” emerge, that are stronger, more efficient and performance-oriented, less reliant on Government funding and more innovative, with the regulator and tax authorities being watchful facilitators rather than gatekeepers.
 
About the authors:
Amrish Shah is Partner, Deloitte India.
Vishal Agarwal is Partner, Deloitte Haskins & Sells LLP.

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