India’s Bank Licensing Flaws: Assessing The ‘Fit and Proper’ Criteria

[By Naman Kothari]

The author is a student of Government Law College, Mumbai.



This assessment delves into the flaws surrounding the issuance of bank licenses in India, with a focus on two crucial aspects. Firstly, it examines the shortcomings of the ‘fit and proper’ criteria, which lack precise guidelines and introduce subjectivity, potentially leading to favoritism and arbitrary decision-making. Secondly, it scrutinizes the refusal of licenses by the Reserve Bank of India (RBI) and the existing redressal mechanism. Specifically, it explores the need for transparency and fairness in the licensing process under the guidelines for ‘on tap’ licensing of universal and small finance banks in the private sector.

The “Fit and Proper” Criteria:

The “fit and proper” criteria entail various requirements, such as the eligible promoters (both individuals and entities/non-banking financial companies) having a minimum of 10 years of experience in banking and finance at a senior level. Additionally, they should possess a track record of sound credentials, integrity, financial soundness, and a successful professional history of at least 10 years. For entities, preference is given to those with a diversified portfolio in the case of Universal Banks. Furthermore, for Small Finance Banks, applicants must exhibit a record of sound credentials, integrity, financial soundness, and a successful track record of professional experience or running their businesses for a minimum period of five years. However, it is noteworthy that these criteria remain highly ambiguous, leaving significant room for subjective discretion by the RBI. The lack of precise guidelines in these areas introduces a potential for arbitrariness and invites allegations of favoritism. Despite revisions to the previous guidelines, this aspect has not been effectively addressed, perpetuating the concerns surrounding the subjective nature of the “fit and proper” criteria.

To effectively assess whether a promoter meets the criteria of being “fit and proper” under the aforementioned guidelines, the RBI exercises its authority to conduct a comprehensive multi-layer scrutiny process. This includes the ability to request additional information from the promoter at any stage of the examination process, ensuring a thorough evaluation. Furthermore, the RBI has the power to collaborate with other regulatory bodies, as well as enforcement and investigative agencies such as the Income Tax Department, Enforcement Directorate, and the Central Bureau of Investigation (CBI), to review the promoter’s history and obtain relevant information. This level of scrutiny provides the RBI with a detailed understanding of the promoter’s background and financial standing. Though this level of discretion also allows a window for potential corruption or undue influence, where applicants may seek to manipulate or circumvent the scrutiny through illicit means. The subjective nature of assessing a promoter’s history, credentials, and financial standing introduces an additional challenge, as it allows for varying interpretations in the decision-making process. This subjectivity opens the door to apprehensions of bias, favoritism, or arbitrary decision-making, thereby eroding stakeholder and public confidence in the integrity of the licensing process.

Refusal of License by RBI and Redressal Mechanism:

Vide its press release dated April 15, August 30, and December 31 2021 the RBI announced names of Applicants under the Guidelines for ‘on tap’ Licensing of Universal Banks and Small Finance Banks in the Private Sector.

A) The applicants under Guidelines for ‘on tap’ Licensing of Universal Banks:

  • UAE Exchange and Financial Services Limited.
  • The Repatriates Cooperative Finance and Development Bank Limited (REPCO Bank).
  • Chaitanya India Fin Credit Private Limited.
  • Shri Pankaj Vaish and others.

B) The applicants under Guidelines for ‘on tap’ Licensing of Small Finance Banks:

  • VSoft Technologies Private Limited.
  • Calicut City Service Co-operative Bank Limited.
  • Shri Akhil Kumar Gupta.
  • Dvara Kshetriya Gramin Financial Services Private Limited.
  • Cosmea Financial Holdings Private Limited.
  • Tally Solutions Private Limited.
  • West End Housing Finance Limited.

On May 17, 2022, the RBI issued its decision regarding the 6 applications out of the 11 names provided earlier. The RBI declared that all applications submitted for the establishment of universal banks, specifically VSoft Technologies Private Limited, and Calicut City Service Co-operative Bank Limited under the category of Small Finance Banks, have been rejected. However, the applications of the remaining candidates are still under examination by the RBI.

It is noteworthy that the RBI did not provide any specific reasons other than deeming the rejected entities unsuitable to receive a banking license. According to the guidelines set forth in 2016 and 2019, the RBI has the authority to reject applications if they fail to meet the “fit and proper” criteria and is not obligated to provide any reason for rejection.

The applicants are also required to submit their business plans along with applications, which should be realistic and viable. The RBI holds the authority to assess the business plan and may impose penalties or restrictions if there is a deviation from the stated plan even after the issuance of a license. The business plan should address key aspects such as achieving financial inclusion, including the underlying assumptions, existing infrastructure, product lines, target clientele, target locations, utilization of technology, risk management, human resources, branch network, presence in unbanked rural areas, compliance with priority sector requirements, and financial projections for a period of five years. It is evident that, alongside the “fit and proper” criteria, the submission of a meticulously detailed business plan plays a pivotal role. It should be noted that any deviations or provision of incorrect information/objectives in the business plan may serve as grounds for rejection.

The process for obtaining a banking license under the 2016 and 2019 guidelines is the same and it involves several stages. Initially, the applications are screened based on eligibility criteria provided in the guidelines, with the possibility of applying additional criteria beyond the prescribed “fit and proper” requirements. Subsequently, the RBI establishes a Standing External Advisory Committee (SEAC), comprising experienced individuals from the banking, financial sector, and relevant fields. The SEAC develops its screening procedures, periodically convenes meetings, and has the authority to request more information, hold discussions, and seek clarifications from applicants. The SEAC then presents its recommendations to the RBI for consideration.

Further in the process, an Internal Screening Committee (ISC) consisting of the RBI Governor and Deputy Governors evaluates all applications. The ISC deliberates on the SEAC’s recommendations and provides its own recommendations to the Committee of the Central Board (CCB) of the RBI. The CCB makes the final decision regarding the issuance of in-principle approval. If granted, the validity of the approval is 18 months, during which the bank must obtain the necessary license. However, suppose any adverse features concerning the Promoters or associated entities are discovered after the approval is issued, the RBI retains the authority to impose additional conditions or even withdraw the approval.

While the process endeavors to uphold transparency by periodically disclosing the names of applicants on the RBI website, it regrettably lacks a robust redressal mechanism. Applicants who are deemed unsuitable for a banking license receive notification of the RBI’s decision without any reason as seen in the case of 6 rejected applicants. Consequently, as there is no obligatory provision to provide for accompanying reasons, the aggrieved applicants are compelled to initiate a separate request to the RBI for the grounds of their rejection, which introduces an unnecessary and time-consuming step in the process. This absence of a clear and prompt reasoning mechanism further curtails the ability of applicants to effectively challenge unfavorable decisions. To enhance the efficacy of the process, it would be advantageous if the RBI, given the rigorous examination it conducts, proactively provides reasons for such rejections, thereby promoting fairness and facilitating informed recourse for applicants.

The redressal mechanism allows aggrieved applicants to appeal the decision of the Committee of the Central Board to the Central Board of Directors within one month of receiving communication from the RBI indicating the non-consideration of their application. However, drawbacks exist within this mechanism, including the limited timeframe for appeal, lack of transparency regarding documentation and procedures, and potential conflicts of interest as the appeal process remains within the jurisdiction of the same institution that made the initial decision. These factors may impede applicants’ ability to present their cases effectively and raise concerns about impartiality and fairness.

In conclusion, while a comprehensive multi-layered scrutiny process is vital in the current era to ensure the integrity and stability of the banking and financial sector, equal importance should be placed on establishing a clear and proper redressal mechanism. Rejections based on the fit and proper criteria can potentially tarnish the image of the banking and financial market, undermining investor confidence and hindering economic growth. Emphasizing the need to build market confidence should be a priority, as it fosters financial inclusivity and expands the customer base at lower levels. By addressing the concerns surrounding the rejection process and implementing an effective redressal mechanism, the RBI can promote transparency, fairness, and a robust banking system.

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