Differentiated Banking -- Is India Really Prepared?

Abstract

The failure of various companies not getting a banking license from RBI and being asked to go back to the drawing board and draft a new application for differentiated permits instead of a full license is a clear indication from the RBI for a greater financial inclusion. According to one of the reports the differential banking activity licenses issued to Regional Rural Banks and Local Area Banks (LABs) could not achieve the objectives for which they were set out which prompted authorities to call for larger size banks to go for rapid financial inclusion in a timed bound and a phased manner. Unlike a single universal bank license which is a blanket license from the RBI allowing banks to offer a range of services, a differentiated license will allow banks to offer specialized services in select verticals like project financing, mortgage banking, industrial financing, etc. Though differentiated banks like cooperative banks, agricultural banks, foreign banks, financial institutions and NBFCs have been a part of the Indian Financial System for long, only a single class of banking license were issued for both domestic and foreign banks and all of them had enjoyed full and equal access to the payment and the settlement system and the deposit insurance cover. But with the introduction of differentiated bank licenses, newer dimensions of banking would emerge and whether this initiative would be able to fulfill the broader objective of financial inclusion or is the idea of a differentiated bank a little premature is a matter of discussion. The differentiated banking practices have been in practice in a number of countries like Singapore, Indonesia, Australia , U.K. & Hong Kong and have been a success there. In India the banks registered as differentiated banks would specialize only in one area of banking thereby leading to higher risk and higher asset-liability mismatches. The Nachiket Mor panel has provided certain recommendations for the setting up of differentiated banks which could be useful. The major challenge that could arise for the regulator is whether it would be able to maintain the systemic stability in the banking system and whether this initiative could prevent banks to indulge in regulatory arbitraging having the lucrative part of the business going to a lot of players and universal bankers being cross-subsidised. The following study tries to understand the relevance of the differentiated bank licenses in the Indian context, the need to have them and to identify the major threats, opportunities and challenges that would emerge due to their emergence.