Rashesh Shah, chairman Edelweiss Group, believes India?s huge pool of savings of $400 billion (which could grow to $1.2 trillion in the next ten years) isn?t being channelised effectively enough to fuel growth.
He tells Shobhana Subramanian that with the new Financial Holding Company (FHC) structure coming into place, RBI would have greater enforcement powers and, therefore, more bank licences can be given to facilitate intermediation.
What do you make of the FHC model as outlined in the RBI panel?s report?
Broadly, it?s fine and it?s good that both the FHC and the subsidiaries can be listed because that way value can be unlocked. But there needs to be some clarity on how much foreign holding will be allowed. For instance, what happens if I am a bank with a 75% FII holding and I have an insurance company with a 26% FDI holding? Would that be permissible under the new structure? There could also be a 100% foreign-owned NBFC, which is allowed to exist as an Indian entity today; so how would that work?
Also, we need some changes in the Companies Act. In the US, for instance, if a company has a 100% subsidiary, it is automatically assumed to be a division of the company. But here, 100% subsidiaries are treated as independent companies and so capital does not flow freely, from one subsidiary to another, thanks to the dividend distribution tax which is 15%. We are forever in the High Court working on some merger or demerger. But if that is addressed, as the FHC guidelines suggest, then we can use capital more efficiently. The MoU between regulators is also a good idea.
Why do you think there is hesitation in giving out too many new bank licences?
I think RBI needs more powers to, say, supersede the boards of companies because today it can?t take too much pre-emptive action. So it needs more enforcement powers and the best thing for financial inclusion in India would be to give banking licences and regulate them strongly, and force them to bring down the cost of intermediation. With greater enforcement powers, it can regulate even the large industrial conglomerates, which today are already in the insurance or mutual fund sectors, and are regulated by Sebi or Irda. The FHC model is a way of increasing the RBI?s enforcement powers.
RBI has withdrawn priority sector status for bank credit to NBFCs for the purpose of on-lending…
RBI has a tough job because NBFCs loans being classified as priority sector will only lead to arbitrage. Should banks give money to NBFCs? The answer is yes, because they can?t get money on their own. Should that be priority sector lending is what RBI is asking and RBI?s argument is valid because you don?t want unnecessary speculative arbitrage. The answer to this is to ultimately make it easier to have banks, start another 100 banks. Why should there be NBFCs, let them become banks. Let them start off without customer deposits, for the first five years, like NBFCs and after they have a proven track record they can start taking deposits. I think it?s in Indonesia that anybody can start a bank with $100,000 of capital but for the first two years your capital adequacy has to be 100%, which means you can only use equity capital initially and borrow only later.
You say the financial system in the country is becoming somewhat jaded…
The environment is becoming very complex. If you look at household savings in 2000, they were about $80 billion; now they are close to $400 billion but the number of banks may have actually gone down during this time because some got acquired. If you want financial inclusion and to build reach slowly, allow intermediaries like NBFCs to become banks and have strong regulation and enforcement. Much like it happened in telecom or aviation, when the sectors were thrown open, innovation will happen and people will figure out how to make a rural branch profitable, how to use business correspondents. Currently, the competitive pressure that leads to innovation in any industry is not as severe in banking. The last time when repo rates were at 9%, interest rates were where they are now; today repo rates are at 7.25% but interest rates are high. Interest rates go up faster when RBI raises rates but they don?t come down so sharply. The banks are able to pass it on because competition is not so severe.
What is really lacking?
In India today, 75% of the financial services space is banking, 20% is insurance and 5% is capital markets. We have $400 billion of savings, which is enough to meet our investment needs but this needs to be channelised in a cost effective manner, so that India?s incremental capital output ratio falls from the current level of 4:1. Today, the cost of financial intermediation in India is very high, there?s no creation of wealth for the saver and neither does the borrower feel he?s getting a good deal. The cost of financial intermediation is estimated at about 4-4.5% whereas globally it?s between 1.5-2%. This has to come down with better technology, skill competition and innovation.
Like it?s happened in the broking industry…
Thirty years ago, the cost of buying and selling shares was 3% and Reliance used to quote at a spread of R200-205. Now brokerages have been reduced to three basis points, or one-hundredth of what it was. The broking business is viable but it?s a question of automation and scale. In those days, you could remain small and survive so everybody stayed small but today we?re forced to scale up and need at least R100 crore of commissions, annually. Institutional broking is a R3,000 crore pool, half of what it was in 2007-08, shared between 20 brokerages, four foreign and six domestic houses. Retail broking is a R8,000 crore pool, so that?s about $2 billion, annually. For a retail broking business to be profitable it needs to have a customer base of about half a million customers, or 2.5 lakh active customers and, on average, they will give you R10,000 in a year or R250 crore of revenue. On this, you can make a pre-tax margin of 14-15% if you are efficient; if you are not, you just about break even. Pre-tax margins have crashed from the levels of 40% in 2007-08 because the industry has become very efficient. Going ahead, with some consolidation and more efficiencies, they could move up to 20%. But 80% of the market will be in the hands of 20 brokers and there will be a long tail.
There?s hardly an equity cult in India. Do you see more individual investors investing directly in the stock markets or do you see them using the MF route?
It?s hard to tell. The world over, there are three routes to investing: directly, through MFs and through insurance and pension schemes. The direct model has worked well in the US with the 401K account, and culturally they like more control; it?s liked in Japan too. The MF route has worked well in the Asian markets like Hong Kong and the insurance route is popular in the UK. In India, there is clearly room for the direct investment model. Today, only 240 million people have a bank account, just around 100 million have insurance policies and 10 million have demat accounts; the top 10 brokers would have seven million accounts if overlaps are excluded. So, there is huge scope for this to grow just as there is in banking?only 30 million people have access to credit and that?s why microfinance has reached an equal number of people. Every year, just four or five million people come into the banking net, which is a very small number, the 240 million should go to 500 million and the 30 million should double. So can the 10 million demat account holders go to 25 million in the next few years? Absolutely.
