Recommendations » India

RBI's new banks licensing norms

Contributed by Angel Broking

How many licenses are likely? 6-8 in our view: The final new bank licensing norms, in our view, are potentially game-changing for the banking sector, as prima facie criteria suggest that six to eight very serious corporates, with deep-pockets (far more than was earlier being anticipated), are likely to get a banking license. As per final guidelines, corporates where promoter-shareholding is less than 49% could effectively qualify - a more relaxed norm than earlier expected.

Hence, with some structuring, amongst the large corporates that have evinced interest, Reliance Industries (RIL), Larsen & Toubro (L&T), Mahindra & Mahindra (M&M), Tata Group, Birla group and Bajaj as well as Shriram group amongst NBFCs could likely qualify. PSU companies by definition have 51%+ promoter holding, so they may not qualify. Similarly, real estate and broking firms may be considered as being exposed to asset price volatility and hence may implicitly not qualify.

Competition in the sector could increase significantly: The guidelines stipulate that the holding company (ie promoter) shareholding will have to be brought down to 40% within 3 years. This could have far-reaching implications regarding the competitive dynamics. The key question is how much equity capital would these large corporates aim to start with. In our view it is unlikely that given the ambitions, massive size and indicative ticket sizes for past diversifications, any of the major corporates would want to start with too small a fresh investment of say, just Rs.500-1,000cr.

As per our calculations, if amongst the 8 licensees put together, the initial fresh investment amounts to a not unrealistic Rs.25,000cr, then by the end of the 3rd year, they would have to raise about Rs.70,000cr of further equity capital from investors to bring down their own share-holding to 40%. If they were to lend 6x the equity investment, that would imply lending of Rs.6lakh cr, which is potentially more than 250 branch additions per annum per licensee and a substantial incremental credit market share of 16%. Operational, HR and asset quality challenges to this appear daunting, leaving the new entrants to figure out the acceptable trade-off between market share, profitability and wealth creation (valuations).

Implications for existing banks: Currently, few private banks are earning RoEs well in excess of 20% in spite of a GDP down-cycle, reflective of the high pricing power enjoyed by the sector inherently. In our view, given the overall increase in competitive intensity, the major implication of new bank licenses is that the sector’s margins and ROEs are likely to decline, including those of existing private banks. We expected PSU banks to lose market share in any case due to capital shortage for them under Basel 3. Now, with new entrants bringing incremental capital as well, the market share loss is likely to get accelerated further. Due to cyclical macro-economic concerns, PSU banks are already trading at depressed valuations. This development creates a structural impediment to medium-term re-rating as well.

In case of existing large private banks, we preferred Axis Bank and ICICI Bank due to their favorable cyclical and structural outlook. But, in light of higher number of likely new entrants over the next few years, whether the larger private banks can sustain 25%+ earnings growth remains to be seen. Considering that the larger private banks still have just about 5% market share each, in our view they can still grow at least at sector growth levels of 17-18% and possibly a little higher. But with the risk of higher competitive intensity, we would expect relatively more moderat upsides than earlier. Similarly, for newer private banks like Kotak Bank (not rated), Indusind Bank (not rated) and Yes Bank, challenges of ramping up a retail franchise are likely to materially increase and could impact valuation premiums.