Over the last two decades, the Reserve Bank licensed twelve banks in the private sector. With the passage of the Banking Amendment Bill, India may well see the floodgates open to more private banks.

To ensure that the banking system grows in size and sophistication to meet the needs of a modern economy and with the need to extend the geographic coverage of banks and improve access to banking services, the Banking Amendment Bill recently got the approval of the Lok Sabha. This happened after the government dropped the controversial provisions relating to allowing banks to trade in futures and keeping the sector outside the purview of Competition Commission.

“Since the bill is too important for me to pass, therefore I am bringing the Bill dropping the controversial clauses,” Finance Minister P Chidambaram said, winding up the discussion on the Banking Laws (Amendment) Bill, 2011.

The Bill, along with proposed legislations on pension and insurance, was one of the five key reforms measures on the government’s agenda during the Winter session of Parliament. As regards other issues, Chidambaram said, while RBI would regulate the banking sector, the Competition Commission of India (CCI) would look into competition practices in the banking sector. The Banking Bill also seeks to raise the voting rights of investors in private sector banks to 26 percent, from 10 percent. It also allows RBI to supersede boards of private sector banks and increase the cap on voting rights of private investors in PSBs to 10 percent, from 1 percent.

The government is also actively considering consolidation in the banking sector, as it feels India will need 2-3 world class banks. Private sector banks are growing and governments’ rationale is that there is no reason why the PSBs should not be encouraged to grow.

All this comes amidst and economy which is slowing and the decks are now cleared for the entry of corporates into the banking sector. The Reserve Bank is soon expected to finalize norms to begin inviting applications for new banks.

With the passage of the Bill, corporate houses like Tatas, Reliance and also entities in the public sector would be eligible to obtain licences to set up banks. “There is a need for more banks and I hope that the Reserve Bank will act with speed in the matter,” Chidambaram was quoted as saying.

Key features of the draft norms are:

(i) Eligible promoters: Entities/ groups in the private sector, owned and controlled by residents, with diversified ownership, sound credentials and integrity and having successful track record of at least 10 years will be eligible to promote banks. Entities / groups having significant (10 percent or more) income or assets or both from real estate construction and / or broking activities individually or taken together in the last three years will not be eligible.

(ii) Corporate structure: New banks will be set up only through a wholly owned Non-Operative Holding Company (NOHC) to be registered with the Reserve Bank as a non-banking finance company (NBFC) which will hold the bank as well as all the other financial companies in the promoter group.

(iii) Minimum capital requirement: Minimum capital requirement will be Rs. 500 crore. Subject to this, actual capital to be brought in will depend on the business plan of the promoters. NOHC shall hold minimum 40 percent of the paid-up capital of the bank for a period of five years from the date of licensing of the bank. Shareholding by NOHC in excess of 40 percent shall be brought down to 20 percent within 10 years and to 15 percent within 12 years from the date of licensing of the bank.

(iv) Foreign shareholding: The aggregate non-resident shareholding in the new bank shall not exceed 49 percent for the first five years after which it will be as per the extant policy.

(v) Corporate governance: At least 50 percent of the directors of the NOHC should be independent directors. The corporate structure should be such that it does not impede effective supervision of the bank and the NOHC on a consolidated basis by the Reserve Bank.

(vi) Business model: Should be realistic and viable and should address how the bank proposes to achieve financial inclusion.

(vii) Other conditions: The exposure of bank to any entity in the promoter group shall not exceed 10 percent and the aggregate exposure to all the entities in the group shall not exceed 20 percent of the paid-up capital and reserves of the bank.

The bank shall get its shares listed on the stock exchanges within two years of licensing. The bank shall open at least 25 percent of its branches in unbanked rural centres (population up to 9,999 as per 2001 census)

Existing NBFCs, if considered eligible, may be permitted to either promote a new bank or convert themselves into banks.

In respect of promoter groups having 40 percent or more assets / income from non-financial business, certain additional requirements have been stipulated.

The bank shall maintain arm’s length relationship with promoter group entities, their business associates, and the suppliers and customers of these entities. The exposure of the bank to any entity in the promoter group shall not exceed 10 percent and the aggregate exposure to all the entities in the group shall not exceed 20 percent, of the paid-up Capital and Reserves of the bank, subject to compliance with the provisions of Section 20 of the Banking Regulation Act, 1949.

All exposures to promoter group entities will have to be approved by the Board. In taking a view on whether an entity belongs to a particular promoter group or not or whether the entities are linked / related to the promoter group, the decision of RBI shall be final. The top management of the bank shall have expertise in the financial sector, preferably, banking. The bank should operate on Core Banking Solution (CBS) from the beginning.

The bank shall make full use of modern infrastructural facilities in office equipments, computer, telecommunications etc. in order to provide cost-effective customer service. It should have a high powered Customer Grievances Cell to handle customer complaints. The bank shall be required to maintain a minimum capital adequacy ratio of 12 percent for a minimum period of three years after the commencement of its operations subject to such higher percentage as may be prescribed by RBI from time to time.

The bank shall comply with the priority sector lending targets and sub-targets as applicable to other domestic banks.