While conceptualizing the financial intermediary called “banks” there are perhaps two distinct views. In one view, a bank typically caters to the short-run working capital requirement of a firm while the long-term finance will come from capital market either in the form of debt or equity. In the financial folklore this model is often referred to as 3-6-3 banking, wherein a banker accepts deposit at 3 per cent, gives a loan at 6 per cent and having earned the spread, proceeds to the gold course at 3 pm! But what happens when the private capital market (both corporate bond and equity) is not sufficiently deep to have the adequate risk appetite to cater to non-working capital needs of a firm. Do we need special type of banks? Or, could a bank act as some sort of a one-stop shop like a financial “Wal-Mart” where depending upon her need and capability, the borrower will go to the appropriate stack and pick up the most suitable “loan” for her needs? This is perhaps the model of ‘universal banking’. Country experiences have taught us that the outcome will typically depend upon the historical context of an economy and that there are successful instances of both bank-based and market-based financial systems. Thus, depending upon its requirements and purpose / sector -specific risk-return profile, an economy may have universal banks or differentiated banks. The recent Reserve Bank of India (RBI) discussion paper on wholesale and long-term finance (WLTF) banks can perhaps be traced in this broad philosophy of differentiated banking.
The concept of WLTF banks as articulated in the RBI discussion paper of April 4 2017 can be traced in the Report of the RBI Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (Chairman: Dr Nachiket More; June 2014) that envisaged a class of differentiated banks called “Wholesale Banks”. Looking into cross-country experience, the present RBI proposal views extends that vision WLTF banks that would focus primarily on “lending to infrastructure sector and small, medium & corporate businesses.” As far as their functions are concerned the report noted, “They will also mobilize liquidity for banks and financial institutions directly originating priority sector assets, through securitization of such assets and actively dealing in them as market makers” (p.10). It may be useful to note the following specific features of these WLTF banks:
- Activities: The primary activities of WLTF banks will be deposits or loan products for wholesale clients and financing of infrastructure sector and core industries. These banks also act as “market-makers in securities such as corporate bonds, credit derivatives, warehouse receipts, and take-out financing etc” and will provide refinance to lending institutions. These banks may also offer investment banking services related to equity / debt investments and forex / trade finance. But unlike investment banks these services will be of ancillary interest to WLTF banks.
- Sources of Finance: Primary sources of funds for WLTF banks could be a combination of “term deposits, debt / equity capital raised from primary market issues or private placement, and term borrowings from banks and other financial institutions”.
- Deposits: These banks may be permitted to accept deposits only “above a large threshold amount” and are expected to have negligible retail segment exposure. Deposits of these banks will have deposit insurance cover.
- Regulatory Requirements: These banks are expected to have a higher level of initial minimum paid-up equity capital, say Rs. 1,000 crore or more. While these banks may be required to maintain CRR they would be eligible for exemption from CRR requirement for the liabilities under infrastructure bonds. Finally, some relaxation in respect of prudential norms on liquidity risk (e.g., Liquidity Coverage Ratio / Net Stable Funding Ratio) may be considered for WLTF banks. Opening of rural and semi-urban branches and compliance to priority sector lending norms would not be mandated for these banks.
Prof. Partha Ray, Professor of Economics, IIM Calcutta writes this piece for the July edition of Economy Watch.