Banking Central | How RBI Urges Banks to Focus on Core Operations in the Era of Financial Supermarkets
Delhi News
The Reserve Bank of India (RBI), often referred to as the “big brother” of banking in India, has outlined new guidelines for lenders regarding their operations beyond the core functions of accepting deposits and providing loans.
The draft circular, issued on October 4, aims to assess the current regulatory framework, ensuring that the core banking business is protected from potential risks associated with non-core activities. Additionally, the RBI seeks to establish a level playing field for all banks in the sector.
Let’s take a closer look at the key points highlighted in the draft circular.
First, banks must manage their core business—accepting deposits and lending money—within their own departments.
The Reserve Bank of India (RBI) allows banks to operate certain services, such as factoring, primary dealership, credit cards, housing finance, equipment leasing, and hire purchase, either within their departments or through a separate group entity.
Key Restrictions and Compliance Guidelines for Non-Core Banking Activities
However, for other services like mutual funds, insurance, pension fund management, investment advisory services, portfolio management services, and brokerage services, banks are only permitted to operate these through a group entity, following specific conditions set for each activity, according to the RBI.
Second, only one entity within a bank group (which includes the bank and its affiliated entities) can engage in a specific type of permitted business and hold or acquire the same category of license, authorization, or registration from any financial sector regulator.
Third, the Reserve Bank of India (RBI) has stated that there should be no overlap in lending activities between the bank and its group entities.
Fourth, a group entity must not be used to bypass any regulations or guidelines that apply to the parent bank or other group entities in order to conduct any business activities that are not otherwise permitted.
The final circular will be based on the comments received on this draft circular.
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What motivated the Reserve Bank of India (RBI) to take this action?
The Reserve Bank of India (RBI) likely acted out of concern over banks increasingly seeking regulatory loopholes by conducting multiple businesses under a single entity. This makes it harder for regulators to identify and address specific issues.
In recent years, major private banks like HDFC Bank, ICICI Bank, Kotak, and Axis Bank have rapidly expanded into financial services such as insurance and mutual funds. These banks have essentially transformed into financial “supermarkets,” offering a wide range of financial products under one roof.
The rapid expansion into various financial services has raised concerns about spill-over risks affecting banks’ core businesses. This prompted the Reserve Bank of India (RBI) to take action to streamline operations. Different financial products fall under the jurisdiction of various regulators—for example, insurance is overseen by the Insurance Regulatory and Development Authority (IRDA), while mutual funds are regulated by the Securities and Exchange Board of India (SEBI).
The RBI’s objective is to clarify the regulatory boundaries for each entity within a bank group. Currently, many banks sell both mutual fund and insurance products through their group entities. On a broader level, the RBI is signaling to banks the need to keep their core business separate from other financial activities, as banks are the custodians of public funds. The increase in cross-selling of financial products has also led to concerns about forced selling and mis-selling, further driving the need for regulatory clarity.
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How will this affect banks?
One potential outcome is that some major bank groups may need to reassess their non-core activities if there is overlap with the RBI’s definition of core business.
“Some banks have NBFC (Non-Banking Financial Company) subsidiaries, which may offer similar products as the bank itself. While services like mutual funds, insurance, and brokerage are generally managed through separate entities, a few banks may need to realign their portfolio management and advisory services,” said Sanjay Agarwal, Senior Director at CARE Ratings.
Additionally, the RBI’s circular will likely require certain banks to restructure their group entities and product offerings to clearly separate core banking operations from non-core activities, Agarwal added.
One relief for banks is that the RBI’s circular offers a two-year window for compliance with the guidelines, although a compliance plan must be submitted to the RBI within two months of the final circular’s release.
More details will become clear once the final circular is implemented.
Banking Central is a weekly column that closely monitors and connects the key events in the banking sector for its readers.