In its monetary policy statement for 2014-15 on 1 April 2014, the Reserve Bank of India (RBI) announced that it would work on a framework for granting licences "on tap" to universal banks, and for granting of differentiated bank licences with the intent to "to expand the variety and efficiency of players in the banking system while maintaining financial stability". This statement had been preceded by a policy paper in August 2013, which recommended reviewing the then prevailing policy of granting licences for establishment of banks on a "stop and go" basis, and instead put in place a continuous authorisation policy.

The RBI issued a draft framework on 5 May 2016 for public comment on granting licences to universal banks on a continuous basis. The draft framework is based on the feedback received on the policy paper, the RBI's experience with the granting of licences to IDFC and Bandhan to establish universal banks, and its experience with the granting of differentiated licences to payments banks and small finance banks. Once issued, the framework will replace the 2013 guidelines for licensing of new private sector banks.

The draft framework prescribes the following entities as eligible to apply for a licence to establish a bank: (a) existing non-banking financial companies (NBFCs) that are "controlled" by Indian residents, and that have a successful track record of 10 years; (b) resident individuals that have 10 years' experience in banking and finance; and (c) private sector entities and groups that are owned and controlled by residents, with total assets of at least `50 billion (US$750 million), a successful track record of 10 years, and where the non-financial business income does not account for more than 40% of total assets or gross income.

The eligibility criteria is considerably narrower than the 2013 guidelines, which allowed private and public sector entities, and NBFCs, to apply for a licence to establish a bank. This provision presumably reflects the intent of the RBI to allow only qualified persons with a proven track record to establish banks and to avoid conglomerates controlling or concentrating bank credit. This also seems to be supported by the prescription in the draft framework that companies or individuals directly or indirectly connected with large industrial houses can hold only up to 10% of the equity of a bank, and cannot have a controlling interest. Such persons will also not be able to appoint a director on the board of the bank.

While the 2013 guidelines made the requirement of a non-operative financial holding company (NOFHC) mandatory, the draft framework exempts applicants that are individuals, promoters and standalone entities that do not have other group entities from establishing an NOFHC as a holding company for the bank and other financial services group entities. As the intent of the NOFHC requirement is to ring-fence the banking and financial services activities of a group from its other activities, this relaxation shows welcome consideration of the RBI to the practical advantages of allowing a simpler holding structure in certain cases.

An overarching theme of the draft framework is that applicants must not only be eligible, but must also be serious about establishing and operating a bank. For instance, while both the 2013 guidelines and the draft framework prescribe that all applicants must submit their business plans along with their applicants, and that the business plan must also address financial inclusion, the draft framework goes a step further by prescribing that in case a successful applicant deviates from its business plan, the RBI may "consider restricting the bank's expansion, effecting change in management and imposing other penal measures as may be necessary".

The use of terms such as "successful track record" in the draft framework, which have not been completely fleshed out, gives the impression that the evaluation of an application will still have considerable element of discretion. Perhaps it is the intent of the RBI to retain this discretion so as to weed out applicants that may not suit its long-term goal of diversifying sources of bank credit and ensuring stability of the financial system.

Importantly, the draft framework clearly spells out the intent of the RBI, that licences will be issued on a very selective basis, to applicants with "an impeccable track record, and who are likely to conform to the best international and domestic standards of customer service and efficiency", and not just to all applicants that fulfil the prescribed eligibility criteria.

This article was first published in the June 2016 issue of the India Business Law Journal (IBLJ) Journal.

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