beyondbrics

India’s central bank is proposing new banking licenses to loosen the state’s grip on the financial sector.

Larsen & Toubro, India’s largest engineering and construction company, has become one of the first local corporate houses to express its interest publicly – and many others are likely to do so soon.

But the central bank’s exact plan is still unclear.

A.M. Naik, the ambitious chairman of L&T, told shareholders at the company’s annual general meeting this week that he was studying a Reserve Bank of India discussion paper, released earlier this month, with a view to applying for a banking licence for subsidiary L&T Finance.

Considerably enhanced by a banking licence, L&T Finance, which specialises in infrastructure finance, might then consider an initial public offering or private equity participation.

The central bank has sought responses from interested parties by the end of September, and is expected to issue a policy decision on new banking licences by the end of the year. Margins in financial services in India are high and competition best described as gentlemanly, so the queue to the door of the RBI’s headquarters in Mumbai is likely to be a long one.

Moreover, many of India’s 1.2bn people are unbanked so whichever private sector bank cracks the business model to tap the country’s savings – particularly in peri-urban areas – could find itself sitting on a proverbial gold mine.

Yet the RBI has some difficult decisions to take in the months to come.

First, it has to answer the question whether it is desirable to let powerful industrial houses enter banking services. This kind of concentration of financial resource sometimes leads to unhealthy cross-subsidisation of financial and industrial operations, with risks for transparency. The RBI has already ruled out real estate companies diversifying into banking.

Second, the central bank has to decide how many banking licences to issue, and whether to offer them in waves (which would give it more time to select the right institutions) or in one tranche (which would give new entrants an equal tilt at the market).

Third, it faces the almost inevitable prospect of disappointing some of India’s corporate leaders. Can the RBI weather the wrath of, say, awarding a banking licence to the Tata Group, but not to one of the Ambani brothers?

Disappointment already looks on the cards for foreign banks, some of whom were hoping that new banking licences might open up opportunities for them to expand branch networks. Some considered the drive by India’s politicians for greater financial inclusion the way to deepen banking operations in the country.

The RBI’s aim is to create strong indigenous banking institutions, and to harness capital within the country to do it. Foreign capital is welcome for a small share of this, but the emphasis is heavily on a “small share” when investment is readily available from within the country.

Engineers with deep pockets, please step forward.

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