Strengthening the Resilience of the Banking Sector

 The main objective of this package of strengthening the resilience of the banking sector is to improve the banking sector’s ability of absorb shocks arising out of the financial and economic stress and to reduce the risk of spill over from the financial sector to the real economy. The package also aims to improve the risk management and governance as well as strengthen the banks’ transparency and disclosures. This improvement is required as the foundation of sustainable economy growth is dependent upon the banking system which in fact acts as the epicentre of the credit disbursement process.

One of the main reasons the economic and financial crisis became so severe was that the banking sectors of many countries had built up excessive on- and off-balance sheet leverage. This was accompanied by a gradual erosion of the level and quality of the capital base. At the same time, many banks were holding insufficient liquidity buffers. The banking system therefore was not able to absorb the resulting systemic trading and credit losses nor could it cope with the re-intermediation of large off-balance sheet exposures that had built up in the shadow banking system. The crisis was further amplified by a pro-cyclical deleveraging process and by the interconnectedness of systemic institutions through an array of complex transactions.

The recent crisis not only affected the banks, financial systems and economies which were at the epicentre, but due to increased globalisation it spilled over to other countries by means of reduced exports, withdrawal of money from foreign investments leading into severe contraction in global liquidity, cross-border credit availability and demand of export.

The committee is achieving the objective by building on the 3 pillars of the Basel II Capital Accord namely, minimum capital requirements, supervisory review process and, market discipline. The reforms raise the quality of the regulatory capital base and enhance the risk coverage of the capital framework.

The key elements of the proposed package can be summarised as below.

Quality, consistency and transparency of the capital base would be raised.

Previously it has been taken that the banks could hold as little as 2% of common equity to risk-based assets before applying regulatory adjustments. Thus the key regulatory adjustments could be used by the banks to show strong Tier 1 ratios with limited equity base. This led to a situation where the write-offs and goodwill amortization would be transferred out of the equity base affecting the capital quality. To implement this, the committee suggests that the majority of Tier 1 capital should be common equity and retained earnings with the rest being financed with the help of financial instruments which are subordinated having full non-discretionary cumulative dividends or coupons and have neither a maturity date nor an incentive to redeem. The tier 2 capital would also be harmonised and the tier 3 capital generally used to cover the market risk would be done away with. To improve the market discipline, the capital would be made transparent as such that the disclosure requirements would be made more stringent with reconciliation of reported accounts.

The Committee's package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6%. The timeline for this has been set to be January 1, 2015. The new capital requirements can be summed as:

	Common Equity (after deductions)	Tier 1 Capital	Tier 2 Capital
Minimum	4.5%	6.0%	8.0%
Conservation Buffer	2.5%	2.5%	2.5%
Minimum plus Conservation Buffer	7.0%	8.5%	10.5%
Countercyclical Buffer	0 – 2.5%

This framework will reinforce the objective of sound supervision and bank governance and address the collective action problem that has prevented some banks from curtailing distributions such as discretionary bonuses and high dividends, even in the face of deteriorating capital positions.

The risk coverage of the capital framework would be strengthened. This would mainly focus on credit risk exposures by means of different financial instruments thereby reducing the chances of the transmission of shocks from one institution to another.

In order to strengthen the risk coverage for the banks, the committee suggests increasing the capital requirements for trading book and complex securitisation exposures. The capital requirements for re-securitisation have also been increased. These reforms would raise the capital buffer for exposure due to banks’ derivatives, repo and securities financing activities. It would also reduce procyclicality and provide additional incentives to move OTC derivative contracts to central counterparties, thus helping reduce systemic risk across the financial system. As per the reforms, banks would be subject to a capital charge for mark-to-market losses associated with a deterioration of creditworthiness of the creditor. Banks with large and illiquid derivative exposures to counterparty will have to apply longer margining periods as a basis for determining the regulatory capital requirement. The package also points towards a need of decreasing the dependence on the external ratings for the banks. In this direction, the committee requires the banks to perform their own internal assessment of externally rated securitisation exposures, eliminate the “cliff effects” (either the peak or the trough) and incorporate the elements of IOSCO Code of Conduct Fundamentals for Credit Rating Agencies.

The package would introduce a leverage ratio, as a supplementary measure to the Basel – II risk-based framework. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for any remaining differences in accounting.

The leverage ratio has been designed to meet the objectives of (a) putting a floor under the build-up of leverage in the banking sector, thus helping to mitigate the risk of the destabilising deleveraging processes which can damage the financial system and the economy; and (b) introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simple, transparent, independent measure of risk that is based on gross exposures.

The committee has also suggested towards introduction of a series of measures whereby the capital buffers would be build which can be used to negate the overall effect of the stressful periods thereby reducing the effect of procyclicality and promotion of counter-cyclical buffers.

As the major work of the banks is to lend and act as a credit disbursement centre, the cyclicality in the sector creeps in as the demand of money is dependent upon the industries which majorly are again cyclical in nature. The measure as listed by the committee would tend to achieve the following:

• Dampen the excess cyclicality of the minimum capital requirement
• Promote forward looking provisions
• Conserve capital to build buffers at individual banks and the banking sector that can be used in stress
• Achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth 

One of the most procyclical dynamics has been the failure of risk management and capital frameworks to capture key exposures - complex trading activities, resecuritsations and off-balance sheet exposures. The measures include the requirement to use long term data horizons to estimate probabilities of default, the introduction of so called downturn loss-given-default (LGD) estimates and the appropriate calibration of the risk functions, which convert loss estimates into regulatory capital requirements. The range of possible measures which can be taken to balance the risk sensitivity and the stability of capital requirements, includes an approach to use the supervisory review process to adjust for the compression of probability of default (PD) estimates in internal ratings-based (IRB) capital requirements during benign credit conditions by using the PD estimates for a bank’s portfolios in downturn conditions.

The committee has proposed stronger provisioning practices though advocating the change of accounting standards towards an expected loss method instead of the present incurred loss method and also changing the supervisory regulations for the same. It is also considering disincentives to stronger provisioning in the regulatory capital framework.

At the onset of the financial crisis, a number of banks continued to make large distributions in the form of dividends, share buy backs and generous compensation payments even though their individual financial condition and the outlook for the sector were deteriorating. Much of this activity was driven by a collective action problem, where reductions in distributions were perceived as sending a signal of weakness. However, these actions made individual banks and the sector as a whole less resilient. More recently, many banks have returned to profitability but have not done enough to rebuild their capital buffers to support new lending activity. Taken together, this dynamic has increased the procyclicality of the system. The committee has proposed stronger tools for the supervisors in this direction.

The committee has also proposed capital conservation norms (which includes the above outlined proposals) mainly focused on adjusting the capital buffer range.

The committee is introducing a global minimum liquidity standard for internationally active banks which would include a 30-day liquidity coverage ratio. Recognising the trends at both the bank and system wide level has also been framed as a step towards growing the resilience of the banking sector.

The interconnectedness of the large banks and other financial institutions had transmitted the negative shocks of the banking sector to the financial system and economy. The committee had proposed the creation of a system to whereby the importance of a bank to the stability of the financial system and real economy would be measured and steps to reduce the probability and impact of the failures of systematically important banks would be taken.

As announced in the 7 September 2009 press release, the Committee is initiating a comprehensive impact assessment of the capital and liquidity standards proposed in this consultative document. The impact assessment will be carried out in the first half of 2010. On the basis of this assessment, the Committee will then review the regulatory minimum level of capital in the second half of 2010, taking into account the reforms proposed in this document to arrive at an appropriately calibrated total level and quality of capital. Taken together, these measures will promote a better balance between financial innovation, economic efficiency, and sustainable growth over the long run.

Globally strong capital base is required for stability in banking sector but that has to be complemented with a string liquid base reinforced through better supervisory regulations.

The Basel committee met on July 26, 2010 and agreed upon the commitment to increase the quality, quantity, and international consistency of capital, to strengthen liquidity standards, to discourage excessive leverage and risk taking, and, reduce procyclicality.

On September 12, 2010, the Basel Committee fully committed itself to norms as designed and discussed by them. Mr Jean-Claude Trichet, President of the European Central Bank and Chairman of the Group of Governors and Heads of Supervision, said that "the agreements reached today are a fundamental strengthening of global capital standards." He added that "their contribution to long term financial stability and growth will be substantial. The transition arrangements will enable banks to meet the new standards while supporting the economic recovery."

Entry of New Banks in Private Sector in India

The Union Finance Minister, in his budget speech for the year 2010-11 had announced that ‘The Indian banking system has emerged unscathed from the crisis. We need to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. Besides, there is a need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable Members that the RBI is considering giving some additional banking licences to private sector players. Non-Banking Financial Companies could also be considered, if they meet the RBI’s eligibility criteria.’

What is the need of new banks in India?

As the economy of a country grows, there is a need of greater financial system depth, stability and soundness. For the growth to be inclusive in nature there is a need of a widespread banking system. Taking a cue from the March 2009 figures, in order to cater to a population of more than a billion, India had 27 public sector banks, 22 private banks, 31 foreign banks, 86 Regional Rural Banks, 4 Local Area Banks, 1721 urban co-operative banks, 31 state co-operative banks, and 371 district central co-operative banks. All India average number of customers being served by a commercial bank remains in the vicinity of around 10,000 people. This in itself gives a quantitative figure which necessitates the development of banks.

Indian banking system has been cautious in its approach. The guidelines for the private banks were laid as late as in 1993 and were revised in 2001. Here also the large industrial houses were not allowed to own a controlling interest in any of the banks, though permitted to own till 10% of the bank.

Promoters of the bank were not allowed to hold more than 40% of the primary equity and in case it was more, they had to dilute the holdings within one year of operations. To add to this, the bank could not lend to any of the promoters. The banks had to be listed on the stock exchange and also they had to lend 40% mandatorily to the priority sector in India with at least 25% of the branches in rural India.

For an NBFC (Non-Banking Financial Company) to be categorised as a bank, it had to meet the stringent criteria like not being owned by a large industrial house, meet the minimum capital requirements (initially 2 billion INR to be increased to 3 billion INR in 3 years of operation as a bank), have the highest possible credit rating of AAA or an equivalent in the previous year, capital adequacy ratio of not less than 12% and NPA (Non-Performing Assets) ratio of less than 5%.

Historically the banks promoted by individuals have either failed or have had to get merged with an established player. The other banks have also not fared well and have been either shut down or merged or are barely able to meet the minimum requirement. Even the small financial institutions like NBFCs face problems as low capital base, lack of professional management, poor credit management, and diversion of funds.

Indian government had formed a committee in December 2004, to enhance both foreign and domestic investment levels in the country. The report submitted in February 2006, suggested increasing the corporate ownership in private banks to 15% and the same to be implemented for the ownership limit for foreign banks in private sector banks. The High Level Committee on Fuller Capital Account Convertibility set in March 2006, submitted its report in July 2006 and recommended the opening of more banks along with increased stake by the corporate players. The High Level Committee on Financial Sector Reform set in August 2007, submitted its report in September 2008 and recommended allowing more entry to private well-governed deposit-taking small finance banks with stipulation of higher capital adequacy norms, a strict prohibition on related party transactions, and lower allowable concentration norms. This would help in reaching more poor households thereby increasing the financial inclusion.

The sub-prime lending brought a crisis which impacted the broader macro-economy, affecting economic growth and employment throughout the world. This crisis amongst other things pointed towards a need of major overhaul in the global financial sector and the associated regulatory architecture, the importance and need of improving the quality and level of capital, risk management, and governance standards, having strong domestic banks, avoiding large and complex banking structures, as well as strengthening the banks transparency and disclosures.

When the licensing of new banks are to be considered, keeping the historical output in perspective, there are certain issues which need to be handled. They can be summarised as:

• Minimum capital requirements for the new banks and promoter contribution
• Minimum and maximum caps on promoter shareholding and other shareholders
• Foreign shareholding in new banks
• Eligible promoters - Should industrial and corporate houses be allowed to promote banks or should the NBFCs be given the license to run a bank or to promote it
• Business model to be followed for the banks

Minimum capital requirements for new banks and promoter contribution

Internationally most of the countries have followed this regime of having a minimum required capital which is considerably high as per the individual economies. As outlined above the Indian limit was initially in 1993 set to be 1 billion INR which was raised to 2 billion INR in 2001 with the requirement of increasing it to 3 billion INR in 3 years of commencement of operations.

There are various possibilities which can be explored.

If the minimum capital requirement is kept low, it would lead to greater financial inclusion and might bring about operational and financial efficiency in the system. This option runs a risk of non-serious entities cashing in on the opportunity and leading to another failure as seen previously. Due to lack of economies of scale and less capital the banks might become vulnerable thus creating the too-large-to-fail banking institutions. The very purpose of bringing the banking reforms of having wider financial inclusion might be defeated. This might also result in creation of lower standards of supervision leading to governance issues.

Having a high capital requirement would mean that the licenses are given only to the full-fledged banks have large capital base, thus strengthening the system. Though this would help the cause of greater financial inclusion, the large banks would be more concerned about the return on investment as the capital involved would be considerably large.

Having an optimal level of capital requirement which is in-between the two, would allow the participants to focus on financial inclusion and also on the business part of the banking system. This would also allow the promoters to reduce their holdings as per the regulations, if need be. This could also mean that the corporations or entities with sample cash would enter into the business, not with the intention of strengthening the banking system, but milking its progress.

Thus the option of having an optimal level of capital may be the best and the case-by-case basis could be used for the new banking system.

Minimum and maximum cap on promoter shareholding and other shareholders

Internationally the range for the promoter holding has been fixed in the range of for 5% to 50%. In Hong Kong, there is no limit in individual promoter holding for banks with only a condition that the financial institution has to be full-fledged bank. There are countries like Canada, where the norms for larger and smaller banks are different with a relative greater degree of freedom being given to the latter.

The guidelines issued in 1993 and subsequently in 2001 looked at reducing the control of functions of banks by the promoters. For requirement of capital base, the promoters are given the liberty to own 50% of the banks’ capital at the start but as per the February 2005 Ownership & Governance guidelines, they are to reduce the same to 10% in a specified time frame. However, under exceptional circumstances and where the ownership is that of a financial entity, that is well established, well regulated, widely held, and publicly listed and enjoying good standing in the financial community, higher shareholding is permitted to a level of more than 10 per cent up to 30 per cent. A level exceeding 30 per cent is subject to higher due diligence standards prescribed in the February 2004 guidelines for acknowledgement of transfer / allotment of shares in private sector banks. RBI has historically also regulated the movement of share capital to and fro the promoters thus putting a check on any wrong doings on the bank’s part.

The above makes the necessary capital to start a bank available and would allow less control on part of the promoters, thus preventing any money-laundering activities. Though this is helpful from an investor’s point of view, the requirement of reducing the promoter holdings to 10% can be a deterrent to a potential investor. This also impacts the working of the banks with regards to the vision, accountability and responsibility for the activities.

Other options would include retaining the general threshold for the shareholders at 5 per cent of capital but to raise the limit for the promoters to 20 per cent in the long run. This would attract serious investors and also serve the purpose of diversified shareholding. The expertise of the promoters would also be available as they would be more focused on the long term gains from the bank considering the higher stake and would bring in more accountability and transparency. This might on the other hand increase the chances of control over the activities of the bank by the promoters. This can ultimately result into development of organisations which are neither professional nor strategic in their vision.

Allowing the promoters to hold their shareholding at 40% would ensure continuing stake of promoters in the bank with all the attendant benefits of providing direction, commitment and resources. This might result into the concentration of the shareholding in a single promoter which is bound to influence the activities of the bank considerably.

A model as suggested by RBI is given as:

Schematically a model for India could be: no restriction on ownership up to 5/10 per cent with permission to hold up to 40 per cent of capital in banks with shareholders' equity up to say 10 billion INR, 30 per cent of capital in banks with shareholders' equity more than say 10 billion INR and up to say 20 billion INR, and permitted maximum holding (10 per cent or 20 per cent) in banks with shareholders' equity of more than say 20 billion INR.

This would ensure long term vision and goals, and direction for the bank. This would also ensure that as the size of the bank increases the promoter would have reduced shareholding allowing professional running of the bank. On the other hand, this can lead to concentration of shareholding in a single promoter and would be detrimental for the growth of especially the smaller banks. A way out for the promoters would be to expand their business slowly so that they can retain their control over bank activities, and this would indirectly affect the flow of money, hence the country’s economic growth. This can also lead to non-transparent shareholding so that the promoters are able to retain the control.

The Canadian model of banking system seems to be plausible which has some disadvantages which can be controlled by specific regulation and case-by-case based analysis of the activities. The option of retaining the threshold for general investors to 5% and allowing the promoters to hold 20% can also be beneficial in the near term especially in Indian context.

Foreign shareholding in new Banks

As per the 2001 guidelines the foreign shareholding was limited to 40% of the total bank share capital and within which the equity was restricted to 20%, effectively allowing the foreign shareholding to be only 8% of the share capital in equity form. Subsequently on March 5, 2004, the Indian government allowed the foreign investment to exceed to 74% by means of FDI (Foreign Direct Investment). FDI policy also requires that minimum of 26% of the share capital has to be held by residents of the country. Individual FIIs (Foreign Institutional Investors) and NRI (Non-Resident Indian) are limited to 10% and the overall limit has been set to be 24% and 10% respectively with a possibility of raising the same using the permission from the regulating body to 49% and 24% respectively. As per the recent circulation the banks having more than 50% of shareholding with foreign investors would be treated as non-resident bank.

Since the objective is to create strong domestic banking entities and a diversified banking sector which includes public sector banks, domestically owned private banks and foreign owned banks, aggregate non-resident investment including FDI, NRI and FII in these banks could be capped at a suitable level below 50 per cent and locked at that level for the initial 10 years.

This would increase the amount of foreign capital available for banks and also being in the technological advancements and collaborations for the Indian banking system to progress. It would also remove the need of downstream investment of banks for monitoring indirect foreign investment. This would also bring some issues like limitation in the foreign capital available in the sector and would in fact be in direct conflict with the provisions of the FDI allowed (74%). 

Eligible Promoters

In a number of countries, the shareholding and the voting rights associated are highly regulated and this reduces the influencing power of the promoters. In India traditionally the industrial houses have had the control over the banks. There are reasons for continuing this and also there are points which negate the need of the present system.

Points in support

• The industrial houses are a large source of capital along with management expertise and vision for the banks to function
• Industrial houses are already present in other financial areas like insurance, asset management, and in form of NBFCs. Thus allowing them to own banks would bring in economies of scale and economies of scope.
• Industrial houses have always harped on new businesses driving the economy and increasing the wealth.
• Large industrial houses are widely held by the public and thus the benefits of the banks growth would be shared amongst the general public.

Strengthening banking regulation & supervision, stronger corporate governance norms, a more competitive banking market and stringent prudential regulations and disclosure requirements could mitigate the risks of affiliations of banks with the industrial and business houses.

Even though Industrial and business houses are already permitted in other areas of financial services, banks are special as they are highly leveraged fiduciary entities central to the monetary and payment system. There are several deep rooted fears in allowing industrial and business houses to own banks. Mainly these relate to the fact that such an affiliation tends to undermine the independence and neutrality of banks as arbiters of the allocation of credit to the real sectors of economy. Conflicts of interest, concentration of economic power, likely political affiliations, and potential for regulatory capture, governance and safety net issues are the main concerns.

There are options which have been discussed below.

Allowing the industrial and business houses to promote banks would allow the movement of the required capital in the bank and as Indian economy grows so will the need for the larger banks with huge capital base. They would also act as a source of contingent source of capital in case the need arises.

There are reasons to negate this option because banking industry has been a high-leveraged industry and would influence the accounting of the industrial houses. As the companies would be having a greater control, the transfer of funds among various entities would result into lack of accountability on part of the bank. This would also prevent the conflict of interest which can arise out of the utilisation of the resources of the bank. Commercial favours may lead to loss of competitiveness as the banks would now be lending only to the favoured clients thereby reducing the options for the borrower. Dealing with complex structures of industrial and business houses would pose a problem for supervision and regulation. As India lacks in stringent penalties for wrongdoings the structure may lead to legal and financial problems. This would also compromise the independence of the banks. The very purpose of financial inclusion might be lost here as the industrial houses would be more concentrating on their development rather than that of the country.

Industrial and business houses that have predominant presence and experience in the financial sector could be allowed to set up banks subject to other due diligence process. This would bring in time-tested organisations and also the professional skills along with expertise would be beneficial for the banking industry. The possible concentration of the economic power in all major areas of business and finance would be a potential threat to financial stability.

As an intermediate step, industrial and business houses could be allowed to take over RRB’s, before considering allowing them to set up banks. This would give added advantage in the form of attracting only the serious industrial houses as they would have to prove their merit in running a bank. This would also limit the negative externalities and can provide an immediate impetus to financial inclusion. Though plausible on first look, this would require a legislative change which might take a long time.

The gradual progress of NBFCs into banking system would give them the opportunity to showcase their capabilities and also develop them as necessary. Also managing RRBs would be an extension of their goals in increasing the financial inclusion.

Should NBFCs be allowed to be converted to banks or to promote a bank?

NBFCs in India includes different kinds of financial institutions which are functionally varying as well as are different in terms of size, nature of activities, and sophistication of operations. They include even smaller players existing in towns apart from the ones owned by industrial houses. In March 2009, NBFCs total assets stood at 957.27 billion INR and public deposits accounted for 215.48 billion INR which is miniscule in value as compared to the Indian banking industry.

Following are the options which have been proposed by the RBI.

Permitting conversion of NBFCs into banks would uphold the ‘fit and proper’ ideology of the banking system. NBFCs have been able to expand the reach of financial system and with them being declared as banks would give them the necessary legal and financial support to implement the idea of widespread financial inclusion. Some of the sectorial credit issues, such as infrastructure and microfinance, could be better addressed if NBFCs specializing in the specified sectors can better leverage their competence by converting to banks and having access to low-cost funds.

There are certain drawbacks in the proposed system. The reach of an individual NBFC has not been substantial and is generally focused on a particular region. Again legislative changes would be needed to bring more supervision and control in the activities of the NBFCs which again would raise the concerns whether the NBFCs would be able to perform under the new and stricter regulations. The NBFCs may not fulfil the ‘well established and well regulated’ criteria and hence the ‘track record’ of an NBFC cannot be taken as an automatic eligibility criterion for conversion into banks. This would also necessitate corporate changes in the NBFCs and it might be that in the quest for better banking the segments being served presently by the NBFCs would move out of the financial inclusion plan as they would not be given the money as they are being given now.

Permitting standalone (i.e. those not promoted by Industrial / Business Houses) NBFCs (including those regulated by SEBI, IRDA & NHB) to promote banks would in addition to the above bring the expertise of NBFCs in handling short-term loans. This option would also allow the NBFCs to retain their competitive advantage of occupying a niche space in the financing industry. Capital constraints would be tackled properly and this would allow for improved governance as well.

There might be certain issues with the utilisation of funds where the new funds could be used for meeting the liabilities of the NBFCs. There would be an extended overlapping in the working of the two different entities which might lead to conflicts.

Thus the option of permitting standalone NBFCs to promote banks is a better option as this would be a gradual step towards achieving the status of a bank by NBFC and would give them a chance to assess their capabilities and build added skills if necessary.

Business Model

The 2001 guidelines on entry of new banks stipulated that the applicants should furnish a project report covering business potential and viability of the proposed bank, the business focus, the product lines, proposed regional or locational spread, level of information technology capability and any other information that they consider relevant. Applications are also supported by detailed information on the background of the promoters, their expertise, track record of business and financial worth, details of promoters' direct and indirect interests in various companies/industries, details of credit/other facilities availed by the promoters/promoter companies/other group companies with banks/financial institutions, and details of proposed participation by foreign banks/NRI/OCBs.

Status- quo could be maintained where new banks could be licensed under the usual conditions giving the new players a level field to play and avoiding any differential supervision and regulation. But this system would not be useful to extend the cause of financial inclusion.

A business model developed on the basis of financial inclusion could be developed and this would attract new banks and encourage them to adopt better methods of banking. But there are problems as the business model heavily oriented towards financial inclusion may not be able to provide commensurate returns to banks to enable them to compete with other private sector banks in the country. With heavy orientation towards financial inclusion involving high cost, cross subsidization of the financial inclusion activities with other gains is not possible. It will create uneven playing field. In case the bank deviates substantially from its proposed business model particularly if its earnings are low threatening its viability, there may not be any regulatory remedy.

The business model to be used should be based upon the financial inclusion, and the formulation can be very useful for the extension of banking system in a phased manner.

The focus of the discussion paper has been on financial inclusion but instead of discussing ways by which more and more people can avail the financial services, the paper focuses on who should be given the chance to implement this. There is a major need of a parallel system of banking at least, to cater to the vast population (nearly 66%) which earns no more than $1.35 daily on an average. Thus the need for financial inclusion is that of a proper banking system to reach the poor instead of developing some financial institutions into banks which would gradually move towards development of services and products for the richer population. One option in terms of business model could be to give a large number of players the license to operate as banks and then as the market progresses consolidation would take place and result into the survival of only the fittest. This option even though sounds good, has the inherent risk of the newly formed banks resorting to uneconomical means to survive.