Why getting a new banking licence is no path for easy money and is just a start of a rocky journey..

The association of banking with hype is as old as the banking industry itself. Pick up any book (old or new) on history of money and banking, and one comes across cases of several banks and bankers who created huge hype in their early years only to bite dust much later. Though, this is a story common across sectors but in banking the connect to hype is much stronger.

So when India have two new licences in 2014, as usual there was hype. As it gave more licences to small banks and payment banks, there was again more hype. One of the payment banks has already surrendered the licence, but there is hardly any mention of it.

This story of IDFC Bank and Bandhan Bank should be nothing new to those who have read a bit of history of banking:

Most of those who scrambled for a banking licence — some to make a quick buck — should be a happy lot. For the two entities that succeeded in getting the coveted licence two years ago, the going since then has been tough. If banking is a cow then one had to transition from an ant and the other had to shrink from being an elephant, both difficult propositions.

In the US, setting up new banks was as easy as opening restaurants. The US market saw formation of more than 2,000 banks between  1990 and 2008, before strong regulations in the wake of the global financial crisis and the fall of banks like a pack of cards put the brakes on the trend. In the next five years, only seven new banks began their journey.

The scenario in the Indian market was vastly different, with just two banks — Kotak Mahindra Bank and YES Bank  — forming in a decade. The country saw the entry of a mere 23 banks since the economic liberalisation in the early 1990s.

It says India opened 23 banks since liberalisation. Not sure how the figure adds up. Ten lprivate banks opened in 1994. Two more in 2000s (Yes Bank and Kotak). Then there were local area banks which actually followed an on tap policy. Some 200 plus applications were received over a period (I think it was 2-3 years) which was then closed. Out of which ten in principle licences were given, five started operations and now four survive. Also add Bharat Mahila Bank. This makes it 10+2+5+1= 18. Something is missing.

But then 23 is an interesting number for Indian banking. Once again 23 banks have been licenced post 2014 (2 scheduled banks +11 payment banks+10 small finance banks)!

The article also says the banks were given under a free banking regime:

The free market strategy started off with the doling out of licences in April 2014 to two very different entities with contrasting backgrounds and cultures — Bandhan and IDFC. The journey since then has been nothing short of an Ayn Rand classic-like tale for them.

How can selective licencing be dubbed as free market strategy?

Then the article points how both IDFC and Bandhan are finding the going tough. Former has to shrink and latter has to inflate in their transition journey. Both were doing fine in their own earlier space of infra lending and microfinance. Welcome to the world of commercial banking..

I don’t know somewhere down the line for both people and owners of banks, banking looks like easy money. The moment there is some announcement of new banks etc opening up, we start feeling as if money is being automatically created and flowing in our pockets. We associate more banks with more prosperity and gains for all. Money is obviously created as banks form majority of money supply, but it does not flow to our pockets as easy as we imagine.

In all this, we just forget how difficult the business of banking actually is. Barring US,  in most places across the world there are just a very few banks. Historically, the process of banking started with many banks in most countries only to either liquidate or merge with other banks. It is quite common to have big five or big three banks in economies with large players dominating much of the scene and small players being there just for namesake. In  US, banking evolved differently thanks to confused policies leading to multiple chartered banks. There are both federal chartered banks and state chartered banks which span the country. The latter are mostly small banks with just one branch. But even within this framework, US too suffers from too biog to fail banks.

Coming to India, we had plenty of banks as well. Before RBI, it was really easy to open banks and as a result banks mushroomed everywhere with all kinds of names. In 1945, we had some 721 banks (scheduled and unscheduled) which had shrunk to just 75 banks (scheduled and unscheduled). In the period, 1945-69, we had large number of liquidations and mergers. Infact in the period 1913-1945, about 960 banks closed. This makes the total number of banks  (of which we have some record) in India as something like 1700 odd. Add cooperatives etc as well and it could be a few thousands.

But then over a period only a handful survived and that too in few locations. This is the key. Lessons were learnt that what matters is not number of banks but quality of banks.

For whatever talk of differentiated banking, it is a commodity business where differentiation is really difficult. It requires all kinds of things to make one’s bank tick and some of these things may have little to do with banking .

So actually thinking that more banks can actually do the trick in India is being ignorant of history. On the more, most new players find it difficult to run the show given how much incumbency matters in banking. State Bank of India was the largest bank 200 years ago and remains the largest till date. Likewise, most nationalised banks (which were actually private banks before 1969) came up amidst lots of struggle in the early 20th century. They still remain prominent players.

The new private sector banks which were created in 1990s rose mainly due to technology. Also policymakers chose to merge most banks in the period with these new players than the old ones. There is little to differentiate in terms of technology as new private banks which are old now  are fairly updated in the space. So, unless these new players can find some patronage from somewhere, it will be difficult going..

 

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