MORE than 40 years after the then Indian Prime Minister Indira Gandhi nationalised the banking sector, the government has finally signalled its intention to allow big industrial houses to re-enter banking business.

Last week, the Lok Sabha, the lower house of the Indian parliament, finally gave the go-ahead for the Banking Laws (amendment) bill, which would enable the Reserve Bank of India (RBI), the country’s central bank, to issue new banking licences.

Before 1969, many big business groups – including the Tatas – were operating banks. However, Gandhi in a bid to win support from leftists nationalised all the leading banks that year and four years later followed up with nationalisation of the general insurance industry. (The life insurance industry had been nationalised in 1956).

It was in the 1990s, when the economic reforms programme was launched by Dr Manmohan Singh, the current prime minister (who was then the finance minister) that the banking sector was once again opened up for private sector participation. Several business groups from the financial services sector, and not connected to industrial houses, were given banking licences. These included HDFC Ltd, a housing finance major, and ICICI, a term lending institution.

Today, both ICICI Bank and HDFC Bank are among the top private sector banks, with market capitalisation exceeding those of most state-owned banks. Similarly, other smaller private sector banks have been established in recent years, transforming the sector by introducing new technologies and processes.

Though the Indian banking sector is crowded – with public sector, old and new private sector, international, co-operative and rural banks in the fray – nearly half the Indian population does not have access to bank accounts. Most of the banks are focussed on urban areas and have largely ignored the rural segment.

The United Progressive Alliance (UPA) government has been eager to allow industrial houses to enter the sector. In fact, most of the top business groups – including the Tatas, the Birlas, the Ambanis (Reliance), the Bajajs and others – already have vibrant financial services companies, insurance firms and other related entities in the sector.

The RBI, however, was reluctant to allow industrial houses to enter the sector, as it did not have any control over these groups.Last year, the RBI had drafted rules allowing industrial companies – but not real estate firms – to enter the sector. It had, however, sought more powers for itself to monitor the industrial firms.

The RBI has been wary of allowing industrial houses to set up banks, fearing that some of them could end up siphoning off deposits to fund their other activities. After much debate, the government finally relented and gave RBI the power to inspect books of other groups companies of the promoters of banks.

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BANKING is considered a sensitive sector and even in the developed world, there are restrictions on the issuing of licences. In the past, before nationalisation, there have been instances when business houses diverted depositor funds to help their group companies.

The global financial meltdown of 2008, caused by aggressive western lenders, saw much of the developed world sink into a recession. Both Europe and the US are still facing problems and these economies have had to pay a hefty price for the unfetteredand risky lending, trading and investment related activities of Indian banks.

The RBI, on the other hand, has been extremely conservative, maintaining a close watch on the banking sector. Despite this, non-performing assets of banks – especially state-owned ones – have soared and the non-banking financial sector (including micro-finance companies) has seen furious growth, raising concerns within the RBI.

Last week, K.C. Chakrabarty, the outspoken deputy governor of the RBI, warned banks that the central bank would be forced to raise the provision coverage ratio (PCR) relating to bad loans, if banks continued to report hefty profits, but ignored provision for non-performing assets.

After the 2008 global financial crisis, the RBI had mandated banks to maintain a PCR of 70 per cent. But three years later, with things improving on the financial front in India, the requirement was lowered. Many public sector banks have now been reporting huge profits, but have cut down their provision for bad loans.

According to the central bank, the NPAs of state-owned banks amounted to 3.3 per cent as on March 31, 2012, up from 2.4 per cent in the previous financial year end. The NPAs for private sector banks were slightly lower at 2.1 per cent, down from 2.5 per cent a year earlier.

Moody’s Investors Service has also maintained a ‘negative’ outlook on Indian banks; last November, it had lowered its outlook on Indian banks from ‘stable’ to ‘negative,’ raising concerns about slower economic growth, asset qualities and high interest rates. The agency expects these factors to continue over the next 12 to 18 months, leading to a further deterioration in asset quality, an increase in provisioning costs and a fall in profitability.

“We view the loan classification (more particularly with regards to restructured loans) and provisioning practices in India as weak and we believe they mask the extent of the banks’ asset quality and capital challenges,” the agency said in a report.

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FINANCE minister P. Chidambaram managed to win the support of the BJP in getting the Banking Laws (amendment) bill passed by dropping a key proposal that would have allowed banks to participate in commodity futures trading. The BJP, which generally backed the banking laws reforms bill, was opposed to allowing them to dabble in commodity futures trading.

Chidambaram also announced that the government would inject about Rs150 billion in public sector banks over the rest of the fiscal (which ends on March 31, 2013) to meet their growing capital requirements. State-owned banks are also expected to hire about 85,000 people as they expand their branch network by 6,000.

Analysts expect much churning in the Indian banking sector over the coming months, especially with the government keen on seeing the emergence of a few banks as global players. State Bank of India (SBI), the country’s largest commercial bank, is eager to merge many of its subsidiaries with itself. With the lower house of parliament having approved the amended law, a merger ofSBI and its subsidiaries is expected over the coming months.

But nationalised bank employees’ unions continue to oppose the reforms measures. Last week, four major unions went on a day’s strike, protesting against the passing of the amendment bill and the planned merger of state-owned banks.

C.H. Venkatachalam, general secretary, All India Bank Employees Association, warns that the amendment bill would dilute the powers of nationalised banks. Unions of state-owned banks are affiliated to left parties and have been vehemently opposed to reforms in the financial services sector.

However, with the emergence of private and international banks and the vast expansion of the ATM network of banks across the country, the general public does not feel the impact of the frequent strikes called by the unions. Most of these strikes are observed around public holidays, so that the employees get to enjoy a string of holidays.

Though the UPA government has managed to get the RBI on board for its proposal to issue new licences to industrial houses, there are serious concerns about how it will go about issuing the licences. The past two years have seen the government facing allegations of corruption for allegedly arbitrarily issuing telecommunications licences for spectrum and for coal mining to favoured companies.

Will it now auction the new banking licences, issue it to a select few industrial houses, or adopt some new transparent processes? Considering the flak that it had to take in the issue of telecom and coal mining licences, the UPA government can be expected to go about this in a more cautious manner.