Sunday, November 1, 2009

RBI gives 'Freedom' to open Branches

RBI recently gave Freedom to Banks to open branches in Centers with population less than 50,000 as per the report of a group constituted by it. This blog had earlier tried to analyse RBI's branch 'expansion' policy.
  • The Branch 'Expansion' policy was originally a branch restriction policy to regulate indiscriminate growth of branches witnessed during 2nd World War.The relevant Act was named Banking Companies (Restriction of Branches) Act, 1946. The policy has been successful in restricting the number of branches in urban areas and thus preventing financial deepening,ensuring lack of competition and fat NIMs(Net Interest Margins) that are one of the highest in the world.
  • RBI has become progressively aggressive in restricting the branch expansions in urban areas.One would presume,prior to 1946 there was no restriction on opening branches. In 1962, Banks were allowed to open 2 branches in an area of their choice for every branch opened in an nonviable/unprofitable area. This ratio became 1:1 in 1968. In 1970 this ratio was made 1:2 for Banks with 60% branches in rural or semi urban areas and 1:3 for rest. In 1977 this was changed to 1:4 plus 1 branch in a metro.
  • In 1990, RBI considered the then prevailing 60000 branches to be adequate to meet Banking requirements. 1 Branch per 15-20 villages or average population per Branch(APPB) of 17000 was also considered adequate then. In 1990 RBI decided to leave it to the judgement of the individual banks to assess the need for additional branches taking into account factors such as business potential and financial viability.
  • Despite this decision and 'achievements',for some strange reasons(inertia might be one) policy remained unchanged till 2005 when RBI bettered 1962 with a ratio of 3:1 by mandating 25% of the new branches to be in rural areas.
  • Importantly,agriculture's share in GDP declined from 58% in 1950 to 38% in 1980 and about 18% currently.So as RBI became more and more adamant on rural branches,their relative attractiveness kept on declining.
  • Apart from the existing category of underbanked districts,the group has created a new category of financially excluded districts numbering 256. A financially excluded district is one in which average population per branch is 19272 and has a credit gap of more than 95%. One may wonder what is special about 19272.This is our national APPB.There are two implications,1)since about half of the districts will always be below average,the policy can continue in perpetuity. 2)Despite the success of Branch 'expansion' policy, our APPB has actually declined from the time RBI declared success in 1990.
  • The financially excluded include state capitals and industrial cities such as these: Ahmedabad, Patna, Jaipur, Raipur, Hisar, Panipat, Ranchi, Kolhapur, Allahbad, Gautam Buddha Nagar ,Lucknow, Meerut.This list might make some bankers happy but a clause governing underbanked districts is likely to apply to financially excluded districts as well.The clause states that centers falling within municipal limits of State Capital, a Metropolitan Centre or a District Headquarters or 100kms from 4 metro cities will be excluded from the relaxation.
  • A category of underbanked states has been created which is also defined as those with APPB below national average. Since some states will always be below average, this list too shall also exist in perpetuity and consists of undivided Bimaru states(except Uttaranchal)+NE+Orissa and West Bengal.
  • The group states that most of the emerging economies require licensing for Bank branches but does not spell out how liberal these countries are in allowing new branches and what are the criterion used. The group also notes that none of the developed countries require licensing for new branches.Should we follow emerging economies or developed?
  • The recommendations do not apply to Foreign banks.
Besides some obvious benefits of scrapping the policy, the group does offer some rationale for continuing with the policy:
  • The present Policy allows RBI to exercise its judgement or (opaque discretion).
  • The present Policy allows RBI to meet with CEOs of the banks and discuss with them critical regulatory matters.In absence of the policy, the CEOs might not want to meet RBI.Brilliant.
  • There can be systemic implications of having too many branches as exhibited by current crisis and the policy is a good substitute for enforcing prudential norms though other means. what are the systemic implications implied?How does the current crisis exhibit that?Did the current crisis come about because there are just too many bank branches in cities like New York and London?
Some counter-factual questions: Could we have had our own Rabo bank if our regulators did not have such good intentions?
Could we have had 100% financial inclusion in urban areas similar to 100% teledensity that we achieved recently in Metros if RBI did not insist of Branch expansion as per its directions?
Will more competition in urban areas force banks to mediate larger number of financial instruments like Mutual Funds,Insurance and Pension?