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Indian Central Bank under Governor Mr.

Raghuram Rajan

Shortly after taking over as the Reserve Bank of India governor in September 2013,
Raghuram Rajan had promised a "dramatic remaking" of the country's banking sector. Rajan
has walked the talk, though the full results of his efforts would be visible only a few years
from now. For example, five years down the line, the Indian banking sector could look very
different from what it is now.
To start with, the near-monopoly of public sector banks, which now account for over 77 per
cent of the loan market, could well be over. Experts say there could be fewer public sector
banks, more niche banks that offer only specific products or cater to a particular group of
customers and more private universal banks. The postal department's ambition to become a
full service bank could also impact the monopoly that state-run lenders enjoy in the
Most importantly, customer choices would change dramatically with technological
innovations, as a result of which lenders which still depend on savings deposits to attract
customers, could face oblivion in the next five years.
"There is definitely change in the air with payments banks, small finance banks and more
universal banks coming in. Three years down the line, you will see many of these things
happening," said Arundhati Bhattacharya, chairman, State Bank of India, the country's largest
lender which controls 17 per cent of the total credit of the banking system.
The changing contours of banks in India
The recent decision of the government to capitalise public sector banks based on their
efficiency could go a long way in ending the muscle power that the state-run banks enjoy, if
the government sticks to the strategy of selective infusion of capital. Weaker banks' survival
would be in question as their ability to raise capital from the market would be limited because
of mounting non-performing loans. For diluting their owner's stake by tapping equity

markets, these banks need the government's approval, and the latter is in no mood to oblige
due to poor valuations.
Data compiled by the finance ministry show public sector banks' combined market
capitalisation is only 36 per cent of the banking sector's total market cap even though they
control 77 per cent of the loan market while their average price-to-book value (P/BV) is 0.67.
In contrast, private sector lenders' market cap is 74 per cent with average P/BV at 2.35.
While observing that the government's move to link capital infusion with efficiency is one
way to incentivise banks for better efficiency, Bhattacharya said only time will tell if
government banks can hold on to their dominance. "It is difficult to predict at this point in
time what will happen. We will have to see whether it (market share) remains where it is now
or comes down to 50 per cent," she added.
A new order
The response to set up niche banks in India after the banking regulator invited applications
from aspirants has been stupendous. Over 100 entities have applied to set up payments banks
and small finance banks, though the central bank made it clear that it will be cautious in
awarding licences.
RBI has also paved the way for wholesale banks, or to be more specific, banks which will
only finance infrastructure projects. RBI has provided incentives for such banks as they can
now raise resources through long-term bonds (with a tenure of at least seven years) and will
not have cash reserve ratio (CRR), statutory liquidity ratio (SLR) or priority sector lending
obligations. However, it is still to be seen whether the concept excites banking aspirants.
There could be another kind of niche banks. Going by the deliberations at the two-day
bankers' retreat (gyan sangam) convened by the finance ministry in Pune, there is a proposal
that small public sector banks should rather focus on their strengths and not try to sell all
kinds of products. "Re-orient portfolios of small PSU banks to differentiate and focus on
specific niches to build capabilities and to optimise capital," the summary of
recommendations released after the retreat said. This could result in some government banks
selling loans only to farmers, and some selling only to small enterprises. The one-size-fits-all

theory could well be a thing of the past, so far as the structure of public sector banks are
There will be more universal banks also, with the banking regulator thinking about "on-tap"
licensing of universal banks, as compared to the current "window" system of licensing. The
guidelines for the same are expected to be released later this year.
Going ahead, the banking sector could look like what global consulting firm McKinsey
outlined at the Pune retreat, which was attended by finance ministry and RBI officials.
McKinsey suggested a three-tier banking structure. On top will be large banks, which can
happen through consolidation of some of the public sector banks, though not many believe
this is possible at this point as most government banks are now busy putting their own house
in order in terms of tackling the steep rise in bad loans. "There is no point in merging two
weak banks, this will have systemic implications," said the chief executive of a public sector
The second is state-linked banks, a proposal which finds resonance with the PJ Nayak
committee. According to the recommendations of the committee, set up to review governance
structure in banks, the government should cut its shareholding below 51 per cent; set up an
omnibus bank investment company, which will be the holding company for all public sector
banks; and constitute a bank board bureau which will appoint board members as well as chief
executives. The suggestions are radical, but if implemented, public sector banks will sport a
completely different look, five years down the line.
The McKinsey report also talked about policy banks. Such entities are also a welcome step as
it will implement the government's policy decisions such as directed lending, which is
currently being done by public sector banks. If these banks are freed from the burden of
directed lending, their efficiency will improve. One step in this direction has already been
taken with the setting up of the Micro Units Development Refinance Agency (MUDRA)
Addressing students of the National Institute of Bank Management in Pune last week, Rajan
said the banking sector will see major changes with the entry of new players, while public
sector lenders will be the biggest "change agents". He has already laid the groundwork for the

"dramatic remaking".


Liberalising banking correspondent regulations so that local agents can extend







Financial inclusion strategy not only to focus on credit but also payment services,


Offer priority sector loan certificates (PSLC) to all entities that lend to eligible









Create stronger boards for large public sector banks, with more power to outside

Reserve Bank of India Governor Raghuram Rajan has big plans to reform Indias financial
sector during his term as the central bank chief.
His strategy takes a cue from Japanese Prime Minister Shinzo Abe, who this summer
unveiled a plan for boosting Japans growth based on three elements, which Mr. Abe calls
They have three arrows, I have five pillars, Mr. Rajan said at an event of The Institute of
International Finance in Washington D.C. earlier this month. Five pillars of reform over the
next few years, he said.

Here they are:

Pillar 1: Monetary policy framework.
Weve got to get our monetary policy framework clear and understood by the broader
public, said Mr. Rajan.
In September, the RBI set up a committee to review its objectives and suggest measures to
strengthen the effectiveness of the banks monetary policies.
And of course, also, bring it up to modern standards of transparency and credibility, Mr.
Rajan said at the event in Washington.
Pillar 2: Reform Indias banking system.
In his inaugural speech as RBI governor, Mr. Rajan announced that banks will be able to
open new branches in India without taking permission from the regulator, which was required
until recently.
That may be something many countries take for granted. But we didnt have that. But now,
we have free branching completely in India, said Mr. Rajan in Washington.
He said the RBI was considering a plan to issue new bank licenses on tap, meaning anyone
can apply to set up a bank at any time. In India up to now, the RBI has given licenses only in
certain periods.
The RBI will also soon come out with new rules for foreign banks, that would give them an
option to set up shop as local companies in India, as opposed to their current structure of
setting up as branches of a foreign parent.
Mr. Rajan said foreign banks which set up wholly-owned subsidiaries will get near national
treatment, including the freedom to set up numerous branches, which they dont enjoy right
Pillar 3: Liberalizing Indian markets.

We want to deepen Indian markets deepen corporate debt market, the government debt
markets, the money markets, as well as derivatives markets (including) interest rate
derivatives, currency derivatives, said Mr. Rajan. He added, however, that some of this will
have to wait till the local markets calm down for a prolonged period.
Pillar 4: Financial inclusion.
Mr. Rajan said that India would look to use technology increasingly to bring financial
services to millions of unbanked people in smaller towns and rural areas.
We have a committee which is looking into how we should do this better, said Mr. Rajan.
Pillar 5: Dealing with financial distress.
Whether it be corporate distress, or financial institution distress: we need to improve our
mechanisms to make it simpler, cleaner, and less value-reducing, said Mr. Rajan.
He has previously said that India needs to accelerate the working of Debt Recovery Tribunals
and Asset Reconstruction companies, so that bad loans sitting on the books of Indian banks
are processed quickly. That will free up banks to lend more to financially healthy companies
that need money.
Mr. Rajan said in Washington that India has already taken several steps toward the goals
described above, such as increasing the amount of investment foreign investors can bring in,
and simplifying routes for their investments.
We canmake a tremendous advance on the financial side over the next few years, said
Mr. Rajan.