New Bank Licences: Silver line in dark clouds

After scrutinising the applications for new bank licences on various aspects, last week Bimal Jalan panel has submitted its report to the Reserve Bank of India (RBI). Yes, this year RBI is planning to issue few new licences to some new players in Indian Financial system. The Central bank issued guidelines regarding licensing of new banks last year. This is the first attempt of licensing in last one decade since Yes Bank and Kotak Mahindra bank were entitled with suffix “Bank” against their name in 2003-04.

Banking system is core of any economy and banks its backbone. Strengthening this sector by providing new licences gives an edge over the existing one. As many as 25 players are in fray of banking licences which includes public sector player like India post and IDFC and private sector Anil Ambani group and Aditya Birla group. Few NBFCs (Bajaj Finance, Muthoot Finance etc) are also competing for new licences.

Public player like India post have greater chances of entitled with banks because of its strong nationwide distribution channel specifically in rural India and having experience in administrating a saving bank scheme and accepting PPF deposits.

Probability of NBFCs getting licences is also high, as these are already in financial business. If NBFCs are given preference to run a bank, then rural and semi urban consumer will be the ones who get maximum benefit because of their already existing network in rural areas. As NBFCs cannot take deposits their cost of funds are high as compared to banks. But when NBFCs are awarded with banking licence their cost of fund will plunge to the comparable cost prevailing in market.

As more players enter the banking space, intense competition among banks might benefit consumers. Banks will focus on reducing operational cost to maintain their market share or to consume market of others which in turn will result in charging low interest rates to consumer in long run. This competitive environment in banking system not only bring down the interest rates but also innovate the whole banking system with new people coming in with their new idea, new thinking style and with new strategies which make system work more efficiently.

India has population of over 1.2 billion of which only 35 percent of population has their bank account. To penetrate more in market, RBI made it mandatory for banks to open “One ATM in rural area with every three in urban area” and bank licences to new players will perform the task of catalyst in reaching out to remaining 65 percent of population which ultimately support the primary objective of penetrating the untouched market to greater extent.

The step taken by RBI is seen as “Silver line in dark clouds (which is hovering on Indian Banking System)” to strengthen Indian Banking system. This gives hope to many economists or to experts regarding expanding reach of Indian banks which make every penny countable and support untouched market to grow if implementation is done properly rather than mere hype.

Dancing Rupee

Their exist a strong correlation in Interest rate, Inflation and Exchange rate. Central bank of any state (RBI in India) make adjustment in Interest rates to keep a check on Inflation and Exchange Rate which have impact on their respective currencies (depreciation or appreciation). The valuation of any currency is relative i.e. it is evaluated with respect to some other currency. This can be understood by the basic "Demand and Supply" principle of micro economics which says "increase or decrease in demand, will back the price in same direction"  and "increase or decrease in supply will have a inverse effect on price". A currency will tend to become more valuable when its demand is higher than supply and vice versa. Or let me put it in more effective manner with an example of dollar vs Indian rupee to understand this in better fashion. Suppose there is increase in demand of dollar i.e. less supply of dollar in market, you would have to pay more Indian rupee to buy one dollar. And here paying more rupee signifies the depreciation of rupee. Similarly when supply is more than demand, rupee appreciate.

Indian economy is drifting through the challenging phase post 2011 with the very existence of recession and inflation together in economy. Measures to control one would worsen the effect of another.With already existing two evils, in recent past, we had seen the third one with the radical and extreme fluctuation in Indian rupee. From 54.76/dollar in month of June to 68.85/dollar on 28th of August, steep downside movement in rupee made the challenges even more challenging. Within a span of just three months rupee plunged down by nearly 21 percent in its valuation against US Dollar. There are many reasons like inflation, interest rate, political uncertainty and many more. Lets see what were the major reasons backing the weakening of rupee to weaken it in more acute way.

The first and the foremost ground, supported the rupee depreciation was Current Account Deficit(CAD). The current account deficit is equal to the trade balance (whether it's a surplus or deficit) + factor income (interest and dividends from international loans and investments) + cash transfers (like remittances from workers in the country to their families abroad).  In simple terms CAD means incoming money is less than the outgoing money, caused a net outflow of foreign exchange means dollar's outgo, results increasing demand for dollar in Indian market, aided rupee to depreciate. Prime reason for widened current account deficit were enormous oil import and import of yellow metal (Gold) on large scale.

Another important aspect for rupee depreciation was the buzz of beginning tapering of the $85-billion per month quantitative easing (QE) that has been on since September 2012. Quantitative easing is the monetary policy used by central bank of the economy by buying financial assets from the commercial banks and private institutes to revive the falling money supply i.e. liquidating the market. The immediate impact would be on rate sensitive bond market where foreign institutional investors (FIIs) had about 30 billion dollars of investments. With the announcement of tapering by Ben Bernanke in June, there had been a massive outflow of some 10 billion dollars of FIIs from their Indian bond market between June and August which had its vast impact on Indian currency market with moving of rupee deep into the ocean.

Few measures taken by RBI and government of India to support rupee are:
1. Government has raised the import duty on Yellow and White metal to check the CAD.
2. RBI will sell Rs22,000 crore of bonds every month to regulate the volatility of forex reserve.
3. Government inked 50 billion dollar of currency swap with Japan and considering another half a dozen                  emerging market with which India can trade in rupee. This lessen the dollar's volatility and give boost to rupee.
4. The RBI has tightened liquidity to reduce money from the system. This increase the short term interest rates, which attract the investor to invest in India.

There were other measures as well taken by RBI to regulate dollar outflow and to boost rupee. All the steps taken by RBI or by government of India are well in place, addition to this I think government should strategies some master plan or should come up with certain proposal to improvise its manufacturing sector which is lagging behind post 70s to reduce the burden of import and flourish export.