RBI push for local area banks

RBI push for local area banks
The Economic Times, December 8, 2009, Page 9

Move To Allow More Banks From FY11 Will Aid Drive For Financial Inclusion

Anto Antony NEW DELHI

THE Reserve Bank of India plans to allow more local area banks from the next financial year to provide an impetus to the government’s financial inclusion drive.

The finance ministry and the central bank have conducted discussions on giving licences to more such banks, as recommended by the Raghuram Rajan committee, after putting in place an appropriate regulatory framework, said a senior finance ministry official.

“They will help to bring in local knowledge to bear on products that are needed locally,” the official said, requesting anonymity.

Local area banks with operations in two or three contiguous districts were conceived in the 1996 Union Budget to mobilise rural savings and make them available for investment in local areas. They are expected to bridge the gaps in credit availability and enhance the institutional credit framework in rural and semi-urban areas.

Although the geographical area of operation of such banks will be limited, they will be allowed to perform all functions of a scheduled commercial bank.

The local area banking licences will be given out in under-banked or unbanked areas of the country. Some of these local area banks could eventually become full-fledged banks at some stage. According to data available with the finance ministry there are 120 unbanked revenue blocks in the country.

The RBI and the finance ministry are confident of addressing apprehensions over the viability of these small banks, the governance structures and the ability of the regulator to take corrective action.

The Raghuram Rajan Committee had envisaged these local area banks as private, well-governed, deposit-taking small-finance banks. They were to have higher capital adequacy norms, a strict prohibition on related-party transactions, and lower concentration norms to offset chances of higher risk from being geographically constrained.

The committee was set up to suggest the next generation reforms for the Indian financial sector. It submitted the report in April 2008.

According to the official, these banks will be on the lines of six local area banks that were given licences by the RBI in 1996. A review committee formed in 2002 had opposed giving further licences, citing regulatory hurdles. Four of the six local area banks set up are still operational.

According to a RBI official, local area banks are likely to have a capital adequacy ratio higher than 15%, while it is 12% for scheduled commercial banks. Capital adequacy ratio or CAR is the ratio of capital fund to risk weighted assets expressed in percentage terms. CAR is the measure of a bank’s ability to withstand losses arising from sticky loans. The local area banks will have higher capital adequacy ratio to offset higher risk arising from being geographically focused.

If the finance ministry’s proposal to consider the local area banks on par with scheduled commercial banks is accepted, the oversight of these banks is likely to rest with the department of banking operations and development in RBI, unlike in the earlier scheme when the department of banking supervision in RBI was in charge of the banks.

But the head of a large public sector bank who asked not to be named pointed out that the business correspondents model being pursued by the RBI will give people access to credit and there is no need to resume the licensing of local area banks.