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Contents

1. Foreword 3

2. Introduction 4

3. Licensing Process: Likely Timelines 8

4. Implementation of the RBI Guidelines: Implications and Impact 10

5. The Way Forward for Successful Applicants 12

6. Strategic Recommendations 15

Annexure 1: Evolution of Guidelines

Annexure 2: Basic Formalities to be Completed for Setting Up Banking Business

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LICENSING OF NEW BANKS IN THE INDIAN PRIVATE

SECTOR: IMPLICATIONS AND RECOMMENDATIONS

Author: Prabhat Gupta

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Prabhat Gupta is General Manager - Regulatory Affairs at L&T Infrastructure Finance Company

Limited.

Earlier, as a regulator with the Reserve Bank of India for close to 25 years, Prabhat has been

closely involved with regulation and supervision of commercial banks and NBFCs as well as the

maintenance of financial stability. He has cited contributions to various Reserve Bank of India

publications and has been associated with many of its internal committee reports on banking

supervision. His areas of expertise include financial risk management, cross-border supervision of

financial conglomerates and financial stability. Prabhat was also on a secondment from the RBI to

Wolters Kluwer Financial Services in 2010-2012, where, as Country Manager and Head Regulatory

Specialist for India, he helped set up their Risk and Compliance business.

Prabhat holds a Masters Degree in Banking and Finance and an MBA Finance from the Welingkar

Institute of Management, Mumbai. He is also a Certified Associate of the Indian Institute of

Bankers.

About the Report Author

M Balachandran has been a career banker for 37 years. He worked in different capacities within

India and abroad for over 33 years in Bank of Baroda, lastly as Chief Executive of the bank’s

American operations at New York. Thereafter he headed Bank of India and superannuated as its

Chairman and Managing Director in 2007. Subsequently he headed Institute of Banking Personnel

Selection as its Director and retired in June, 2012. Mr Balachandran has had extensive exposure

to Agriculture and SME banking besides Corporate and International segments and Human

Resource Management.

He was also instrumental in founding the Star Union Dai ichi Life Insurance Co., a joint venture

between Bank of India, Union Bank and Dai Ichi life insurance Co of Japan and was its founder

Chairman for 3 years.

Presently Mr Balachandran is RBI’s Nominee Director on the Board of National Payments

Corporation of India (NPCI), and chairs its Management Committee of the Board. He is also on the

Board of Chartered Financial Management Ltd as Independent Director and PNB MetLife Insurance

as Nominee Director of Punjab National Bank. Other committees with which Mr Balachandran is

current associated with are - Chairman, Committee for Review of Depositories System in India

(SEBI); Chairman, Expert Group for Merger of Urban Co-op. Banks (RBI); Member, Research and

Development Advisory Committee of National Housing Bank (NHB); and Trustee, DHAN Foundation.

About the Foreword Author

3

FOREWORD

- M Balachandran

The entry of new participants in the Indian banking industry over the next couple of years will,

hopefully, be a catalyst for the banking industry to rise to the next level in terms of corporate

governance, operational efficiency, customer engagement and wider geographical coverage.

While there is no debate that public sector banks have provided yeoman service in the area of

rural banking and serving the underprivileged section of the country for the last few decades,

it was the entry and proliferation of private sector and foreign banks in the country that

created a technological revolution in the industry to provide entirely new levels of customer

experience and service delivery, setting new standards for the old players also to cope with.

Will we witness a similar shift to a higher banking paradigm with the entry of new banks, this

time with an additional and much needed focus on inclusive banking similar to what we saw

after the private banks entered into the market in the nineties?

Inspite of the public sector banks' sustained endeavours to create infrastructure for banking

in the unbanked countryside, the banking accessibility still continues to be evasive to

significant sections of society both in rural and urban areas. This has made the government

and regulators contemplate new modes and means for 'inclusive banking', and permitting new

banks to be set up is one of the steps in that direction.

This time, new banks will have to direct significant attention towards their strategy to pursue

operational excellence and deploy innovative service delivery models, combined with

impeccable standards of corporate governance, to ensure that they get the required return on

capital as per their risk appetite, and at the same time, ensure conformance to the stringent

norms set forth by the regulator.

Although some of the bank license aspirants command a high mind share with their existing

customers in their current areas of operation, it remains to be seen how they would translate

this into market share for banking services in the short to medium term, especially to reach

the hitherto unbanked as well as to provide significant competitive differentiation to the

'already banked'. Deploying a contemporary, robust and scalable technology infrastructure

combined with the right mix of qualified and experience people, at both the board levels and

at the management and operational levels, will be imperative to achieve these goals.

The post-Lehman era has seen a slew of new regulations for risk management the world over,

and in India it has been no different. How a new bank achieves effective risk management

balanced with new and sustainable business growth in the wake of increasingly pervasive

delivery channels such as mobile banking, combined with fleeting customer loyalty, will

ultimately determine not just the persona, but also the financial viability of the bank. With

many bank aspirants already having a fairly well set corporate culture in their existing

business, this is a path that will have to be tread carefully.

The entry of new banks is expected to provide a boost to the economy with new opportunities

being created not just in the new banks, but in support sectors such as training and

education, marketing services, real estate, technology and business process outsourcing.

Banking being a business of trust, the entry of new banks will create a tremendous demand

for reputed senior bankers to provide their expertise and experience in helping the new banks

compete effectively with their more mature peers. As the banking industry grows, so will the

market for allied financial products.

With a fresh optimism set to grip the banking industry, this report and the author's views on

the foreseeable developments do give creditable indications on the likely implications and

impact of the new banking licenses, as well as some recommendations on strategic, statutory

and regulatory issues to be coped with by the new bank aspirants.

Licensing of New Banks in the Indian Private Sector:Implications and Recommendations

4

INTRODUCTION

The banking system is the pivot of the Indian Financial System. Recognizing the

potential of the banking system to promote broader economic objectives viz. the

planned economic development in India, accorded focused attention to the banking

system to build up a financial infrastructure that was geographically spread out and

functionally diverse for resource mobilization and its deployment towards the pre-

determined economic priorities.

The evolution of the Indian banking system has passed through three distinct phases in

terms of ownership, nature and type of institutional structure and the regulatory

framework. During the first phase, stretching up to the initiation of planned economic

development in 1951, the Indian banking system was considered as immature and

rudimentary. The second phase coincided with the adoption of a mixed economy with

a growing accent towards industrialization. This phase saw the need for alignment of

sources of finance with planned priorities that led to the nationalization of 20 private

banks. With the liberalization and globalization of the Indian Financial System,

especially since the reforms in 1991, the third phase has witnessed discernible

transformation in the operation of banking systems and the introduction of prudential

norms, dovetailed to international best practices. This phase witnessed the re-

introduction of private banks, albeit with adequate entry level restrictions.

Over the last two decades, the Reserve Bank of India (RBI) has licensed twelve banks in

the private sector. This has happened in two phases. Ten banks were licensed on the

basis of guidelines issued in January 1993. The guidelines were revised in January 2001,

based on the experience gained from the functioning of these banks, and fresh

applications were invited. The applications received in response to this invitation were

thereafter vetted by a High Level Advisory Committee constituted by the RBI, and two

more licenses were issued (Kotak Mahindra Bank and Yes Bank).

The origin of discussions on permitting ownership in Indian banks to corporate, that

have led to the RBI issuing the present guidelines, can be traced to the High Level

Investment Commission constituted by the Government of India in December 2004. In

its report of February 2006, the said Commission, among others, recommended

permitting ownership in Indian banks of up to 15 percent by Indian corporates and also

to increase limits of holdings by any one foreign bank up to 15 percent in private banks.

In July 2006, the report of the High Level Committee on Fuller Capital Account

Convertibility constituted by the RBI, also recommended that RBI should evolve policies

and to allow industrial houses, on a case to case basis, to have a stake in Indian banks

or promote new banks. The report also recommended that policies be evolved to

encourage non-banking financial institutions (NBFC) to convert into banks and till 2009

foreign banks be allowed to enhance their presence in the banking system.

The September 2008 report of the High Level Committee on Financial Sector Reforms

(Dr. Raghuram Rajan Committee) further recommended entry to private well-governed

deposit-taking small finance banks with the stipulation of higher capital adequacy

norms. The Economic Survey 2010-11 also suggested industrial houses be given

banking licenses in order to promote the goal of financial inclusion, subject to attendant

regulatory robustness.


5

The Union Finance Minister made an announcement in his budget speech for 2010-11,

that the RBI was considering giving some additional banking licenses to private sector

players. Non-Banking Financial Companies could also be considered, if they met the

RBI’s eligibility criteria.

In pursuance of the budget announcement, the RBI put out a Discussion Paper on its

website on August 11, 2010 inviting feedback and comments. The Discussion Paper

elicited wide response from the general public, consultants, existing banks, industrial

and business houses, NBFCs, micro finance institutions etc. There was extensive

discussion in the media through analytical pieces as well as editorial opinion. The RBI

also held discussions with important stakeholders. The gist of these comments and

discussions was placed on the RBI’s website on December 23, 2010.

The draft guidelines on ‘Licensing of New Banks in the Private Sector’ were framed

taking into account the experience gained from the functioning of the banks licensed

under the guidelines of 1993 and 2001 and the feedback and suggestions received in

response to the Discussion Paper. The draft guidelines were placed on the RBI’s website

on August 29, 2011 for comments. The comments received on the draft guidelines were

examined and after taking into account important amendments in December 2012 to

the Banking Regulation Act, 1949, and consultation with the Government of India, final

guidelines were issued in February 2013.

With a view to assist potential applicants in understanding the terms of the final

guidelines in a better manner, clarifications on the guidelines were provided by the RBI

in June 2013. Based on the final guidelines and such further clarifications, 26 applicants

submitted their applications to the RBI before the cut-off date of July 1, 2013,

requesting grant of an in-principle license to form a banking company in India.


Interview

How will the banking landscape change with the

entry of new banks in the country?

If you look at where the focus of the market is today, it

is around two dimensions. One is about creating a USP

for every aspect of customer interactions. The other

dimension is about dealing with the data that is being

built up within the organization, either from an insights

perspective or from the perspective of finding an

intersection of risk, analytics and profitability.

Essentially, the primary question is - what is the key

differentiating service that a bank can offer to its

customers. All of them require an ability to operate in

a multi-channel model and hence we see a lot of

potential in this space.

The new banking licenses will likely disrupt the

industry as each of these banks look to differentiate

their services or even target different but profitable

customer segments to deliver better service. These

new banks have a challenge as they compete with

established players which will fuel a new wave of

innovation in the market place.

Mobile, Internet and Social Media will drive a lot of

interest in the future as banks strive for that extra edge

in making their customer engagement more intimate,

retain them longer and get them to do most of their

transactions via non-traditional channels.

What are some of the global and local best practices

that the new entrants should consider, especially in

the areas of governance, risk and compliance?

At Oracle, we have a large and diverse customer base

in the FSI Industry globally and in India. We have

worked as the technology partner successful private

banks such as HDFC Bank and Yes Bank and also a

number of Financial Inclusion Institutions; this gives us

a defined perspective to appreciate changes in this

sector. These changes are taking shape through

multiple parameters, from demographic changes in

various countries and geographies, to the level of

technology adoption in various markets. For example,

Jibun Bank, a new bank in Japan has built an

unprecedented model by designing a mobile virtual

bank that gives its user- financial institution open for

business anytime, anywhere on the move.

In emerging markets, banks are focusing on moving a

large part of the parallel economy into the legal

economy. The growth driver lies simply in regularizing

In conversation with Chet Kamat,

Chief Executive Officer & Managing Director,

Oracle Financial Services Software Ltd.

August 20, 2013

6

Oracle has a compelling

value proposition for new

bank licensees, because

we can bring together

the entire technology

stack in a pre-integrated

fashion that substantially

reduces time to market

for them.

Interview

the system. Banks in most part of Asia are looking at

leveraging technology uniquely in order to meet the

constraints they face in the marketplace. In mature

markets like Europe, banks are facing a unique

situation of an aging and shrinking population. They

are over-banked, the costs are high and hence banks

are looking for technology to lower their operational

costs. Besides these regional trends, there is the

evolution of mobile and internet, which is pushing

innovation, and there is the continuous pressure from

regulatory changes that is driving change in banks

operations.

In India, we have a fairly robust regulatory

environment which has for decades seen a robust and

healthy banking environment. As the drive for

expanding the banking customer base widens to

newer segments, these will bring their own intrinsic

risks. Such as, onboarding the unbanked segment

means that banks will have to evolve new practices in

KYC and credit evaluation. As banks expand into new

medium like social media and explore the boundaries

of possibilities with mobile technologies, security and

privacy risks will need to be managed and last but not

least, these are challenging times for the economy,

and the entire banking sector will need to pay special

attention to market risks.

How will the new entrants be able to leverage

technology to compete effectively with the

entrenched players?

In the last couple of decades, technology has brought

standardized processing capabilities across banks.

Now, one can set up a bank anywhere; bankers can

have an everyday complete view of the status with

their customers and counterparts on an on-going,

real time basis.

New entrants have multiple choices that will help

them take on the challenge of competing against

incumbents head on and carve out a differentiated

position. They can opt to enter in either the retail

banking or the corporate banking space. Within the

corporate banking domain, they can start with

specialized and niche services like payments, trade

finance etc. Their preference will depend on their

long-term plans for growth and diversification.

The retail banking model on the other side is also

going to be very interesting. With a stipulated

mandate to have 25% of all branches in rural markets,

the new banks will have to innovate to gain the

competitive edge particularly as they will face stiff

competition from incumbents in the urban markets.

They will need to leverage technology to keep their

costs down, bring in unique products and value added

services to differentiate themselves and use the

different channels of Internet, mobile and others in

ways that have not been done yet. This is where Oracle

has a compelling value proposition for new bank

licensees, because we can bring together the entire

technology stack in a pre-integrated fashion that

substantially reduces time to market for them.

What should new banks do to build an

infrastructure that is capable of serving the

financial inclusion aspirations of the regulator and

government?

Financial inclusion is a crucial element of sustainable

growth. However, there are few obstacles that banks

will have to overcome. Sustainable growth is not

possible without having commitment for financial

inclusion and ensuring that the unbanked get banked.

In the next few years a lot of young people from the

350-400 million odd middle class section in India will

make the workforce. They will have innumerable

options in terms of investments. How will you get them

included in the banking sector and invest in the right

areas? Technology is the key here that will help in

increasing social mobility and smooth delivery of

banking technologies and products. Also, the

engagement level with your stakeholders who are so

many today- customers, market, regulators and

employees is important. It's great that today

everything is mobile driven, however, how do you get

more and more products and services through that

platform is the challenge to be resolved. Oracle with its

range of innovative products and services is catering to

the technical needs in this space.

Oracle's technology relieves the key pressure points in

today's financial services market that arise from

increased regulatory interventions, highly complex

global operations and customer demand for new

services. It integrates a solid, secure foundation

technology foundation with the adaptability and

extensibility to meet changing market conditions.

Indian companies have global aspirations and are

actively looking to enter global markets, either through

organic or inorganic routes. Oracle technologies are

simpler, help them integrate their businesses as

quickly as possible and work as a single system.

7

LICENSING PROCESS: LIKELY TIMELINES

The process of licensing new banks in the private sector at RBI began on July 1, 2013,

by which date all applicants were to submit their formal applications in the specified

format. As announced by the RBI, 26 applications have been received from applicants

from varied backgrounds like Government sector, large corporate houses, well

established NBFCs, micro finance institutions, financial advisory services etc. In order to

ensure the smooth processing of these applications, RBI has set up a “New Banks Cell”

consisting of a small group of officers and staff, within its Department of Banking

Operations and Development (DBOD) at its Central Office in Mumbai.

The RBI guidelines specify that since banking is a highly leveraged business, licenses

shall be issued on a very selective basis to those who conform to the stipulated

requirements, have an impeccable track record and are likely to conform to the best

international and domestic standards of customer service and efficiency. Therefore, it

may not be possible for RBI to issue licenses to all the applicants meeting the eligibility

criteria prescribed. The process of licensing the new banks by RBI could therefore turn

out to be one of elimination rather than selection.

At the first stage, the applications would be screened by RBI to ensure prima facie

eligibility of the applicants. RBI may apply additional criteria to determine the suitability

of applications, in addition to the ‘fit and proper’ criteria prescribed in its guidelines.

Given the fact that there are 26 applicants and a humungous amount of information

(pertaining to the last 10 years of operations) submitted by each applicant and

assuming that it could, on an average, take at 3-4 working days to analyze each

application, it could be estimated that it could take around 20 weeks for the initial

screening of applications to be completed.

Added to the initial screening, in cases where the applicant groups are large diversified

corporates or include companies that are regulated by other regulators, RBI would be

seeking such feedback from these other regulators on these companies, as it deems

appropriate. Therefore, the preliminary screening by RBI could in likelihood, be

completed by December 2013.

8


Expected Licensing Timelines

9

Once it completes its initial screening process, the applications would be referred to a

High Level Advisory Committee headed by Bimal Jalan, ex-Governor, RBI. The RBI

guidelines allow for the High Level Advisory Committee to set up its own procedures for

screening the applications. The Committee would reserve the right to call for more

information as well as have discussions with any of the applicant/s and seek

clarification on any issue as may be required by it. The Committee would thereafter

submit its recommendations to RBI for consideration, which is expected to be any time

between January 2014 and April 2014.

On receipt of the recommendations from the High Level Advisory Committee, the final

decision to issue an in-principle approval for setting up of a bank would be taken by

RBI and the proposed bank applicant/s would be informed accordingly. Bearing in mind

that the completion of these formalities at RBI could take an additional 4 to 6 weeks,

the in-principle approvals are likely to be issued between April 2014 and June 2014.

The validity of the in-principle approval issued by RBI would be eighteen months from

the date of its granting the in-principle approval and would thereafter lapse

automatically, should the proposed bank not commence operations by then. Therefore,

the bank would need to be set up within eighteen months of RBI granting the applicant,

its in-principle approval.

Even after issue of the in-principle approval for setting up of a bank, the RBI guidelines

stipulate that if any adverse features are noticed regarding the Promoters or the

companies/entities with which the Promoters are associated and the Group in which

they have interest, RBI may impose additional conditions and if warranted, it may

withdraw the in-principle approval.

Assuming the amount of time it may require the approved applicants to set up the bank,

one would hope to see banks commencing operations from any time between

September 2015 and December 2015.


10

IMPLEMENTATION OF THE RBI GUIDELINES: IMPLICATIONS AND IMPACT

Financial Inclusion and Priority Sector Lending

An important consideration for the approval of bank license will be the regulator’s

perception of the commitment from applicants to serve the unbanked rural areas in the

country. Given that 25% branches will have to be located in hitherto unbanked areas,

this is expected to have a significant bearing on the way applicants set up their business

models. This hurdle will prove to be a significant challenge especially for those

applicants who already have branches in developed areas, as they will have to take a

decision on adding one additional branch in an unbanked area for every four existing

branches in developed areas. The resultant capital and manpower required, and the

expected return on investment thereon, will determine whether applicants from this

category actually increase their existing branch network, or in fact, optimize it in order

to meet the guidelines.

Achieving the 40 per cent priority-sector lending targets (comprising agriculture,

micro-small-medium enterprises, education, housing and export credit) at par with

established banks within the mandated three years, combined with the fulfillment of

statutory reserve requirements that include placing 4% deposits with the RBI and

holding 23% in government bonds will place heavy demands on profitability and capital.

This will substantially lengthen the time taken for an applicant to establish a serious

presence. Infrastructure finance companies with large existing loan portfolios that have

little or no prior presence in the required sectors are likely to find the target most

challenging. These strict conditions imply that profitability for the new banks is likely to

be limited until they secure a strong foothold.

Implications for NBFCs

For applicants running an existing NBFC business, the move away from their core

competencies and well-managed operations into new businesses and unfamiliar risks

with additional regulatory hurdles may put pressure on their capital. They will have a

challenge meeting the CRR, SLR and priority sector requirements from the first day of

operations since they already have assets in the form of advances and investments.

Moreover, they would need low cost Current Account Saving Account (CASA) deposits as

matching liabilities since bank funding would have to be repaid (banks cannot borrow

from other banks). Since all lending has to necessarily happen from within the bank,

those NBFCs that have an infrastructure financing company would have a challenge

meeting the asset-liability mismatch once the infrastructure advances are taken into the

bank’s balance sheet. The other significant implication for would be the huge

provisioning norms for non-performing assets and re-structured accounts, which

would be a burden on capital as well as the CRAR.

Legal and Regulatory Issues

Corporate groups, NBFCs and public sector entities can set up a bank only through a

wholly-owned non-operative financial holding company (NOFHC). The NOFHC,

registered as an NBFC, will hold the bank and other financial services entities of the

promoter group. The objective is that the holding company should ring-fence the

regulated financial services entities of the group, including the bank, from other


11

activities of the group. However, it remains to be seen how the legal and regulatory

issues of such a structure are straightened out, for e.g. the Insurance Regulatory and

Development Authority (IRDA) does not allow insurance companies under the umbrella

of the financial holding company.

Implications on Investment

As per the guidelines, the new banks are likely to need to invest in new systems and

processes to manage new asset risks. The transformation of existing franchises will be

slow, as most will have to start from scratch. Applicants who are already established

NBFCs and have presence across various financial services, will be better placed to

switch to bank status, though with the challenges outlined earlier. Considerably large

investments will be required in information technology, systems, human resources and

real estate, the returns from which will need time to fructify. Information technology (IT)

companies, automated teller machine (ATM) vendors and real estate agencies are

expected to gain substantially with the entry of new banks.

Market Impact

New entrants are unlikely to increase competition in the short to medium term because

of the additional profitability pressure from their expansion plans and the financial

inclusion conditions imposed by the regulator. The 10-year gap since the last round of

new banking licenses means that existing operators are well entrenched, especially in

urban markets. The cost of funds will be a significant hurdle, as deposits from current

and savings accounts (CASA) will not be easy. Existing banks, such as Kotak Mahindra

Bank and Yes Bank, still offer the highest interest rates on CASA, though they have been

in existence for 10 years. The entire banking sector, including new licensees, will have

to raise huge sums in Tier-I capital over the next four years to meet Basel III norms. That

means an expansion of capital base, including equity, which in theory should reduce

valuations. FPO and debenture issues will be successful only if floated by institutions

with good reputations and strong balance sheets.


12


THE WAY FORWARD FOR SUCCESSFUL APPLICANTS

“I was ecstatic to have finally achieved my goal......only to realize that my journey had

just begun....”

The grant of the coveted ‘in-principle’ banking license by RBI to any one of the 26

applicants will only be the first step towards setting up of the bank. What follows for the

applicant is a tedious and procedural maze of completing formalities and obtaining

permissions (Annexure 2). The importance of the period between obtaining the in-

principle license up to actually being awarded the license can be gauged from the fact

that RBI has unilaterally extended this period from twelve months to eighteen months.

It is during this period that the successful applicant would actually demonstrate its

capability to create the necessary infrastructure for setting up the bank.

With RBI stating that any non-compliance will attract penal measures including

cancellation of license, the period after receiving the in-principle license is one where

applicants will require having in place an intricate and detailed time-bound

implementation plan.

Constituting a Project Implementation Group

An immediate requirement for guiding the process of setting up the bank after receiving

the in-principle license would be the setting up a Project Implementation Group. This

group would typically consist of specialists with necessary expertise in areas like retail

and wholesale banking, regulatory compliance, secretarial, systems, information

technology, treasury, taxation, rural, macro-economics etc. Applicants may also

consider appointing external consultants to lend support and bring in the necessary

professionalism to the final outcome. However, as the requirements and business model

of each applicant are likely to be different, it should be ensured that the external

consultants’ advice is customized and dovetailed to the business plan. The group would

also benefit by familiarizing itself with the regulatory and supervisory structure of the

RBI and the impact of various existing and upcoming regulations across various

departments of the bank.

Business Plan Implementation

The RBI Guidelines have very categorically stipulated that the business plan submitted

by the applicant should be granular, realistic and viable. The business plan also needs

to address how the bank proposes to achieve financial inclusion. In case of any deviation

from the stated business plan after issue of the banking license, the regulator could

consider restricting the bank’s expansion, effecting a change in the bank’s management

and/or imposing other penal measures as it may deem necessary. It is therefore

imperative that all aspects within the business plan, whether it is sectoral focus, branch

network or rural coverage, are executed in all earnest by the applicant on being granted

the banking license. Also, as the banking business is highly susceptible to external

factors in the economy like interest rates, foreign currency rates and inflation, the

proposed bank will have to continuously keep track of such macro-economic scenarios

to ensure viability and currency of its business plan. The performance of the bank in

terms of achieving its stated business plans will continue to be monitored by the RBI

well after the bank has been awarded its banking license, and the proposed bank would

be well-served by religiously adhering to the plan.

13

Information Technology

Banking today has become increasingly technology-driven, and given the volume of

transactions in the Indian context, virtually every aspect of a bank is now based on

technology. In fact, technology in the banking sector has been helping to deliver

financial services with greater efficiency and affordable costs, without compromising on

levels of safety, security and reliability. The RBI guidelines have stipulated that the

proposed bank would need to operate on a Core Banking System platform from the

beginning, along with all modern infrastructural facilities for all banking operations

including treasury, trade finance, corporate banking, retail banking and wealth

management. This would involve considerable planning and investment by the

proposed bank depending on its business plan, branch network, financial inclusion plan

and staffing strategy. In addition to technology, skilled staff with cross domain

expertise will be required for effective technology implementation especially in complex

and data-intensive areas such as analyzing transactional data for financial modeling

and risk management under the Basel framework and transaction monitoring and

reporting under the Prevention of Money Laundering Act.

Besides, RBI guidelines in the recent past have required the extensive use of technology

to improve efficiency and productivity, in its various projects like Automated Data Flow

(ADF) of regulatory reporting from the bank to RBI, Cheque Truncation System (CTS),

and other platforms for ensuring accurate and timely payment and settlements, trading

platforms, financial inclusion driven technology etc. Hence, before the proposed bank

embarks on its Information Technology strategy, it would be well served by updating

itself on the RBI thinking in this regard which has been articulated in the RBI Vision

Documents on IT Systems (2011-17) and Payment Systems in India (2012-15). Also, an

RBI Working Group had, in January 2011, recommended enhancing guidelines relating

to governance of IT and information security measures to tackle cyber fraud apart from

enhancing independent assurance about the effectiveness of IT controls.

Talent Acquisition

Banking is a process of two way intermediation, with the receiving of funds on one hand

and their adequate and remunerative deployment on the other. Irrespective of the fact

that the promoters of the new bank may have been involved in financial services in the

past, the functioning of a bank requires specialized knowledge and skill. Hence, in order

to ensure smooth banking operations, it is a pre-requisite that adequate thought and

planning are involved in acquiring and attracting the appropriate human talent to the

bank. A practical road block for the talent acquisition process for the proposed bank

could be the appropriate timeline for initiating the hiring process. The identified people,

especially those at the top level, may be hesitant to commit or come on board unless

the bank receives its in-principle approval. On the other hand, if the process of hiring

is initiated only after receiving the in-principle license from RBI, a valuable period of

time from the allotted eighteen months for setting up the bank would be lost.

Defining the Risk Appetite

Risk governance demands a holistic approach and risk appreciation needs to start at the

top. A strengthened management information system (MIS) supported by robust

information technology platform is therefore a necessary pre-condition for enhancing

board-level efficiency in oversight and decision making for the bank. In addition to


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prescribing a risk appetite for the bank, the board also needs to lay down the

appropriate risk strategy and ensure that this is institutionalized throughout the bank.

This would entail aligning risk management processes with the overall business

strategy, clearly defining the roles and responsibilities down the hierarchy, establishing

accountability and reinforcing change with communication and training.

Customer Engagement

A steep rise in customer expectations has been evident over the years across financial

services and new bank aspirants will have to give deep thought to ways in which they

should heighten customer experience, especially at a retail level, vis-à-vis the

competition. While investing in the right technology to enable seamless customer

relationship management is almost a given, efforts will have to be channeled towards

ensuring that the new bank addresses the opportunities and challenges provided by a

rising digital-savvy population, especially in the area of mobile banking services.

Corporate Governance

The RBI guidelines have, at more than one instance, laid great emphasis on the

corporate governance it expects from the proposed banks. This emphasis and concern

by RBI stems from the fact that it expects the management of the bank to be adequately

skilled and trustworthy enough to manage the bank in an efficient manner. The

guidelines hence contain several safeguards in the form of prescribing demanding

criteria for the corporate structure and fit and proper criteria for the promoters. The

guidelines also aim to ensure appropriate corporate governance by stipulating that the

board should consist of a majority of independent directors. Ensuring good corporate

governance positions the bank as trustworthy and ensures that both, the regulator and

the bank customer, have the necessary confidence in its operations. Good corporate

governance, to begin with, can be ensured by identifying persons with integrity as well

as the appropriate knowledge and experience being appointed as independent

directors, who could be a part of the various internal committees of the bank where they

could lend their expertise to further add value.

There has to be a realization that no amount of regulation can be a substitute for board-

level governance. Therefore, while effective regulation furthers corporate governance in

the bank, effective corporate governance ensures that the objectives of the regulation

are met, with minimal regulatory intervention.


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STRATEGIC RECOMMENDATIONS

Time-Bound Implementation Plan

With the RBI stipulating an eighteen-month period for the proposed bank to put the

necessary infrastructure in place to commence banking business and to demonstrate its

capability to do so, it would be an understatement to say that having a practical and

time-bound plan of action will be of utmost importance. This would include the various

regulatory and operational activities that need to be completed within this period within

the appropriate individual timelines, as well as assigning the responsibility of

completion of each of these activities to respective individuals with the Project

Implementation Group. Deciding on the appropriate business activity for the ‘in-

between period’ between receiving the in-principle approval till the final bank license

will be key to the success of the implementation plan.

Re-Organizing the Existing Financial Business

In the case of those promoters who already have an existing line of financial business

that would subsequently merge into the new bank, the dilemma during the eighteen-

month period would be the extent and type of business they would like to continue with,

given the implications it could have on the proposed bank’s balance sheet, on its

merger. There could also be concerns surrounding asset quality and provisioning

requirements upon merger and promoters need to think about this seriously. Similarly,

the existing financial businesses would need to take business decisions on expansion

plans, recruitment of fresh talent, brand recognition, acquisitions etc during this period,

and at times, may need to sacrifice short term gains in the interest of the new bank.

They would also need to guard against any adverse operational risk events in their

financial businesses during this period that could have an adverse implication on the

proposed bank. The re-organization of business and transfer of assets and liabilities to

the new bank from the existing financial entity is a process that needs to be done

diligently and demands great attention to its impact on capital and regulatory

requirements of the new bank.

Financial Inclusion is Key

With the RBI guidelines stipulating in no uncertain terms that the new bank has to

achieve specific performance and coverage levels in unbanked rural centers, there needs

to be in place a viable and more importantly - believable - plan by the proposed bank

to ensure financial inclusion. An appropriate starting point in the new bank’s financial

inclusion strategy would be to look at this as a business opportunity and not as a social

obligation. The new bank needs to adopt a sustained approach towards financial

inclusion by focusing not just on improving access to financial services but ensuring

continuous and increased usage of banking services through appropriate financial

literacy initiatives. While the adoption of innovative business models and delivery

channels to expand financial inclusion is important, leveraging information technology

will be key to financial inclusion, as it will enable attaining greater reach and penetration

of providing financial services at an optimum cost.

Learning from Peers

A distinct advantage that the new banks are likely to have is the luxury to learn from


16

the achievements and pitfalls of existing banks in India and globally. Especially in

specific areas like risk management, financial inclusion and information technology,

new banks could well learn from the best practices adopted by more mature banks, with

the caveat that they should guard against blindly aping a practice or procedure being

applied by another bank without understanding the implications on its own operations,

capital and profitability.

Constant Communication with the Regulator

Banking is one of the most heavily regulated financial services activities globally. In the

aftermath of the global financial crisis, regulators have been seen to be in overdrive

mode, not just for introducing new and more complex regulations, but also in actively

reviewing existing regulations. In such a scenario, not only does the new bank need to

keep track of the evolving regulations, it would also need to quickly interpret and

disseminate the new guidelines across the bank. The bank could also keep an eye on

evolving regulatory policies of global standard setting and regulatory bodies, as more

often than not, with time these translate into local regulations. Given that the new bank

licensee is unlikely to have the necessary experience at a deep level at the early stages

to completely comprehend regulatory policies, it must make an endeavour to be in

constant and regular communication with the regulator. While this would no doubt

considerably ease overcoming teething trouble for setting up the bank, it would also

help convey to the regulator the sincerity and sense of purpose of the bank. In addition,

regular interaction with the regulator would also help the proposed bank understand

the various hurdles being faced by other new banks during their setup phase.

CONCLUSION

Though banking is often seen as a glamorous form of financial services, a successful

bank is one that believes in performing the routine banking functions and transactions,

over and over again, in an efficient and error-free manner.

Banking is primarily a business of ‘trust’. No bank can succeed over a long period, if it

does not have the trust of its depositors and borrowers. Among the various risks that a

bank is exposed to, reputational risk is the one that could harm even a financially sound

bank. Hence, while the new banks would need to use the eighteen month period after

being awarded the in-principle license by RBI to set up the necessary infrastructure for

the bank, they would do well to keep in mind during this intermittent period, to also

build trust, comfort, security and customer loyalty for themselves.


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ANNEXURE 2

Basic Formalities to be Completed for Setting Up Banking Business

i. Applying to DBOD, RBI for initiation of the process for inclusion of the name of the proposed bank in the second schedule tothe RBI Act 1934.

ii. Approval from DBOD, RBI for the appointment of the Chairman, Managing Director and other Executive Directors of theproposed bank.

iii. Formation of mandatory committees as stipulated by RBI from time to time.

iv. Framing of important policies by the bank relating to investment, credit, risk management, branch network, outsourcing,compliance, customer service, record maintenance etc.

v. Authorized Dealer (AD) license from RBI to deal in foreign exchange.

vi. Obtaining a three digit bank code, BSR code and AD code from the Department of Statistics and Information Management (DSIM)at RBI.

vii. Membership from the Deposit Insurance and Credit Guarantee Corporation (DICGC).

viii. Opening a Current Account with the Deposit Accounts Department (DAD) at RBI.

ix. Process involving opening of a Subsidiary General Ledger (SGL) Account with the Public Debt Office (PDO) at the concernedregional office of RBI.

x. Obtaining membership to the Negotiated Dealing Settlement (NDS) from the concerned PDO at RBI.

xi. Membership of the Clearing Corporation of India Limited (CCIL) for various segments of trading (Government Securities, ForeignExchange, COBOL etc).

xii. Approval from IDRBT for membership and connectivity of the Indian Financial Network (INFINET).

xiii. Registering for a user name and password from RBI for its Online Filing and Reporting System (OFRS) to submit regulatoryreturns online.

xiv. Obtaining the necessary software from various departments in RBI (DBOD, DBS, FED, RPCD, DSIM etc) for online filing ofreturns..

xv. Gaining membership of the Clearing House at RBI.

xvi. Applying to the RBI for availing of the facilities of Payment and Settlement Systems like RTGS, NEFT, ECS etc.

xvii. Approval from the Department of Banking Supervision (DBS) at RBI for the appointment of Statutory Auditors. Thereafterappointing the Statutory Auditors.

xviii. No Objection Certificate from RBI for connectivity to / operating of SWIFT.

xix. Obtaining membership of Foreign Exchange Dealers Association (FEDAI) and Fixed Income and Money Market DealersAssociation (FIMMDA).

xx. Applying for membership to SROs like the Indian Banks’ Association (IBA), Banking Codes and Standards Board of India (BCSBI),Indian Institute of Banking and Finance (IIBF) etc.

xxi. Obtaining approvals from RBI for setting up the Aggregate Gap Limit (AGL) and Net Open Position Limit.

xxii. Obtaining approval from RBI for dealing in Cross Currency Operations (if any).

Some Important Guidelines - Statutory, Regulatory and Prudential

a. Maintenance of a Statutory Liquidity Ratio (SLR).

b. Maintenance of a Cash Reserve Ratio (CRR).

c. Maintenance of Capital to Risk Weighted Assets Ratio (CRAR).

d. Exposure norms for single/group borrower and Capital Market (direct as well as indirect.

e. Lending to Priority Sector.

f. Notification of Base Rate.

g. Guidelines on Risk Management and Capital Adequacy and Market Discipline - New Capital Adequacy Framework (NCAF) - BaselII/III.

h. Know Your Customer (KYC) norms / Anti-Money Laundering (AML) standards/ Combating of Financing of Terrorism (CFT)/Obligation of banks under PMLA 2002.

i. Guidelines on Branch Authorization as per Section 23 of the Banking Regulation Act, 1949.

j. Guidelines pertaining to the implementation of the Foreign Exchange Management Act, 1999 (FEMA).

k. Guidelines on Outsourcing of Financial Services.

l. Guidelines on Currency Management - operation of currency chests, exchange of notes and coins and detection and impounding

of counterfeit notes.

m. Operative guidelines on payment and settlement transactions.

n. Guidelines on Customer Service in banks.

o. Setting up the Compliance Function in the bank.

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