Is there a case for differentiated licensing in India?

Source: RBI Discussion Papers on Banking Structure-28.08.20!

5.35 Gradually, but discernibly, market focus is shifting to customer specific and niche
products. Many banks keep the plain vanilla banking as a small necessary segment. In
October 2!, "eserve #ank had prepared a discussion $aper on %ifferentiated #ank
&icensing '"#I, 2!(, )herein it )as stated that the case for differentiated licensing
may be revie)ed after a certain degree of success in financial inclusion is achieved and
"eserve #ank is more satisfied )ith the *uality and robustness of the risk management
systems of the entire banking sector.
5.3+ ,ith the broadening and deepening of financial sector, a need is felt that banks
move from the situation )here all banks provide all the services to a situation )here
banks find their specific realm and mainly provide services in their chosen areas. -s the
economy gro)s and becomes more integrated )ith the global economy, need )ould be
felt for sophisticated financial services and products )hich )ill re*uire the presence of
different types of banks. In this conte.t, the /)elfth 0ive 1ear $lan has pro2ected the
infrastructure financing re*uirement for the country at 34 5 6 trillion during the plan
period. /herefore, for instance, specialised banks )hich can cater to the infrastructure
needs of the gro)ing economy may be re*uired. 4imilarly, there could be a need for
)holesale banking facilities. 7urrently, the )holesale banking space in India is occupied
mostly by foreign banks and the ne) generation private sector banks. -ccording to
Mckinsey '266(, )holesale banking revenues, )hich in India account for close to 3
percent of total banking revenues, are e.pected to more than double, from roughly 56+
billion in fiscal 26 to 535 to 58 billion by 265. It is )idely recogni9ed that banks
providing services to retail customers have different skill sets and risk profiles as
compared to banks )hich deal )ith some specific clientele like large corporate clients,
infrastructure firms, etc. 0or a )holesale bank dealing )ith corporate clients only, it
becomes a costly ad2unct to maintain a limited retail banking presence. Moreover it
becomes difficult for such a bank to meet the obligations for doing inclusive banking.
5.3! /he pros and cons of a differentiated licensing regime are:
Pros
i. /here are diverse opportunities in the banking and financial landscape reflecting
significant macro;economic gro)th potential in India and differentiated licensing
could enable unlocking potential of these opportunities as it encourages niche
banking by facilitating specialisation thereby reducing potential non;optimal use
of resources. <ach of the niches mentioned belo) has the potential to be
individually large to sustain significant balance sheets and specialised entities
can play a ma2or role in all of them.
ii. =ery large ticket, long term infrastructure lending re*uires risk management
e.pertise that goes beyond traditional credit appraisals at banks. /here is
significant space for speciali9ed entities in risk assessment and structuring of
infrastructure finance.
iii. =ery lo) ticket unsecured credit re*uires risk management methodology and cost
control that is not easy in business model of conventional banks.
iv. Gaps in 4M< finance can be filled )ith asset based lending, operating leases,
and factoring.
v. Issues of conflict of interest )hen a bank performs multiple functions )ould not
arise, )here differentiated licences are issued.
vi. "isk management systems and structure for regulatory compliance could be
customised according to the banking type.
vii. 7ustomised application of supervisory resources according to the banking type
could result in greater optimisation of such scarce resources.
viii. 7ore competency could be better harnessed leading to enhanced productivity in
terms of reduced intermediation cost, better price discovery and improved
allocative efficiency.
Cons
i. Given the e.tent of financial e.clusion in India, such a regime )ould be a path
a)ay from carrying banking to masses particularly if large number of banks )ere
to opt for this.
ii. $riority sector lending could be impacted as specialised institutions may not
have to meet the e.tant targets for such lending, )hich is other)ise applicable to
all commercial banks. In fact, recently, )ith a vie) to streamline priority sector
lending, norms for such lending )ere revamped in the light of the
recommendations of the >air 7ommittee.
iii. Many niche;banking models typically depend on inter;bank li*uidity, and )hole
sale funding )hich is a potential source of risk and vulnerability in a crunch
situation.
iv. 3nlike specialised banks, banks engaging in various kinds of activities )ill find it
easier to cross subsidise across various sectors and optimum utili9ation of
resources and therefore ensure better profitability of banks.
v. 4peciali9ed banks may be prone to high concentration risk as their business
)ould be focused on a particular area.
5.3? On balance it )ould appear that differentiated licensing )ould be a desirable step
particularly for infrastructure financing, )hole sale banking and retail banking 'focussed
on 4M< financing(. /he small banks 'discussed in 7hapter 8( could also be under
differentiated licensing regime )ith restrictions on their area of operation, si9e and
range of activities. /hese banks )ill have to be under differentiated prudential regimes
depending on their risk profile. 0or e.ample, the reserve re*uirements and capital
ade*uacy and e.posure norms etc. could be different from that of universal banks.
4imilarly, there could be restrictions on some of them accessing retail deposits or
)holesale deposits or deposits altogether.
5.3@ -s regards the attendant conditions laid do)n in "#IAs discussion paper of October
2! for considering differentiated licence, it may be stated that banks have sho)n
significant progress in financial inclusion and in improving the *uality of risk
management though a lot more needs to be done.