Banking Regulation

Critically evaluating the draft guidelines for “on-tap” bank licences put up by the Reserve Bank of India, it is argued that India’s banking system is already sufficiently competitive, and there appear to be few who would be willing to enter the banking business. Entry of newer players, especially those with corporate backing, cannot be the priority at the moment. The priority over the next two or three years has to be the resolution of the non-performing assets problem and strengthening of the existing players.

This paper argues that cooperative banks face higher risk of failure than commercial banks, due to softer regulatory and supervisory arrangements, highly impaired capital and asset structure, inadequate corporate governance and lack of professionalism. Yet, these two sets of banks have been clubbed together in the same rights and capacity under a unified deposit insurance scheme. The Deposit Insurance and Credit Guarantee Corporation is making huge payments on account of failure of cooperative banks and this is threatening the viability of the deposit insurance system and thereby financial stability of the country. Though there are numerous problems in extending deposit insurance cover to cooperative banks even under a separate scheme, still there may be compulsions to do so. For the viability and effectiveness of the deposit insurance system for cooperative banks, it is essential that the deposit insurance system be set up within a prudential framework. However, such an arrangement may entail significant increase in the deposit insurance premium payable by cooperative banks.

Since the beginning of the financial sector reforms in early 1990s, boundaries between products and intermediaries have been blurring rapidly. The entry of several large government-owned as well as non-governmental financial sector participants in a variety of related domains such as securities trading, investment banking, commercial and retail banking, insurance and asset management which are regulated by independent bodies has posed some unique supervisory challenges for the Indian financial system. The paper attempts to argue that such a system of regulation not only artificially fragments the financial markets but also exposes the system to the very real danger of participants behaving as mini-super-regulators as they seek to optimally allocate capital dynamically between these fragmented market