Banking dreams

EDITORIAL

Owning a bank gives the promoter a high. But it actually entails many responsibilities. Banks are entities with the highest leverage. There is no restriction on the amount of deposits a bank can accept. The restriction a bank faces is on asset creation in relation to the capital funds. On the capital front too, a bank gets a little leeway. It is allowed to raise perpetual debt and classify it as core (or Tier I) capital alongside equity and reserves. Thus, it is clear that banking is all about using public money to earn profits. All this is possible with a capital base (equity plus reserves) less than one-tenth the total assets. ICICI Bank’s total assets at the end of December 2009 was Rs 3,56,228 crore. It had deposits of Rs 1,97,653 crore and other borrowings of Rs 91,479 crore. This is the extent of leverage by ICICI Bank based on a net worth of Rs 52,240 crore. No wonder then that a bank is highly regulated and also its activities closely supervised. Unlike banks, non-banking finance companies (NBFCs), particularly those not accepting deposits from the public, have greater operational freedom. If NBFCs like Sundaram Finance, Manappuram Finance and Muthoot Group have decided against converting into banks, then it is understandable that they don’t want to subject themselves to the rigours of regulation by the banking regulator. The Finance Industry Development Council (FIDC) might describe banking regulations as restrictive, but those are necessary controls. Banks are the engines of an economy. Hence, it is essential to keep a check on the health of individual banks and also that of the banking sector as a whole to ensure a clog in its functioning does not rock a smooth-sailing economy. The extent of damage a banking system failure can cause is still fresh in our minds. Large scale defaults on sub-prime mortgage loans in the US caused a global credit squeeze and the resultant collapse of investment banking firm Lehman Brothers, which in turn, led to a global economic downturn. FIDC co-chairman, Raman Aggarwal, says NBFCs have a problem with directed lending to segments identified by the centre and the RBI as priority sectors, which include exports, housing and lending to the poor. These segments are all profitable businesses, provided done with adequate risk management tools in place; same as in glamorous businesses like lending to companies. The NBFCs that have announced intentions of becoming banks have ambitious promoters. The ambition of owning a bank will drive these promoters to apply for a banking licence once the RBI issues guidelines for fresh licences. This ambition will keep them in the business of banking, which is really tough given the highly regulated environs. And the key to a stable banking business will be the faith of the individual depositors, the source of major chunk of the basic source of raw material – funds to lend. Larger NBFCs, which don’t want to convert into banks fearing “restrictive” regulations, should beware that the RBI has begun to tighten its regulatory screening of bigger non-banks. It has already started classifying NBFCs with assets worth Rs 100 crore and above as systemically important finance firms. The capital adequacy requirement for these firms has been raised to 15 per cent from March 31, 2011 onwards, against 9 per cent for banks. The large NBFCs will have to pay a price in terms of higher capital for not being subjected to tougher norms applicable to banks.