Rajan,
the RBI governor, delivered an impassioned speech at the Competition Commission
of India on Tuesday, where he laid out the two "grand bargains"
between banks and government that shaped the country's present financial
landscape – and more recent developments that are breaking them down.
Under
the first bargain, he explained, commercial banks received low cost deposits,
access to the RBI's liquidity facilities and "some protection from
competition" in return for financing the government, opening branches in
unbanked areas and making loans to priority sectors (farmers and students, for
instance).
Rajan
said this bargain is "under threat" as banks increasingly face
competition from financial markets and real assets for household savings, while
the government "cannot continue to pre-empt financing at the scale it has
in the past".
The
central bank is "committed" to lifting the barriers of entry facing
new banks. It granted two new commercial bank licences last month and is moving
towards a system where banking licences will be available all year round – or
"on-tap", as Rajan put it.
This
does not mean that every pretender will be handed a licence – Rajan stressed
that only "those who have a proven track record and reasonable
capital" will be approved. There are, however, ‘differentiated' licences
available for smaller institutions and "those who see synergies in doing
only one part of the banking business" such as payments.
"Small
banks tend to be better at catering to local needs, including needs of small
and medium businesses," Rajan explained, while "a payments bank,
which will take deposits and offer payment and remittance services but be
constrained to invest all its funds in safe instruments such as government
securities, could be very synergistic with other existing services."
Not
everyone is convinced of their value. Rajan said some of his colleagues at the
RBI consider payments banks "unviable", while others are concerned
they would "skim the cream of banking business away from regular
commercial banks". Rajan, however, seems ready to take a leap of faith.
Payments
banks would, he argued, reduce the obligations imposed on commercial banks,
specifically by buying government securities (for liquidity purposes) and
allowing commercial banks to diversify.
Rajan
also called for changes to the role commercial banks play in achieving financial
inclusion. Even if they are forced to extend financial services to remote
areas, he said, banks will not necessarily reach out to the local population.
"The
reality is that if the mandate is unprofitable, banks will find ways to avoid
them," he said. "Not all forms of inclusion can be made profitable,
but we should give banks the freedom to try new approaches, perhaps drawing in
other institutions that can traverse the last mile to the underserved where
necessary."
The
second bargain Rajan outlined was between the public sector banks and the
government. These banks undertook "special services and risks" for
the government, he explained, and received their backing in return.
Public
sector banks tend to fund large, risky infrastructure projects. Rajan warned
this kind of financing is becoming more sophisticated, and public sector banks
may struggle to meet the new challenges as "past hiring freezes have
decimated their middle management" and they are "constrained by
government rules and second-guessed by vigilance authorities".
