Local Area Banks

Some of the infirmities of LABs are, no doubt, in-born. They do not have freedom to expand business even after fully exploiting the ‘local’ potential, which constrains their revenue models. Focussing on 2-3 districts does not enable them to diversify their risks. Any ‘local’ shock may easily topple their fortunes. Dr Manas R Das The origin of Local Area Banks (LABs) can be traced to an announcement made in the (regular) Union Budget 1996-97 Speech by the then Finance Minister, P. Chidambaram. Following salient points emerged from this announcement: wp:list LABs were to be in the “private” sectorLABs were to be “local” focussing on a limited two to three “contiguous” districts, instead of being pan-IndiaLABs were to mobilize “rural” savingsRural savings so mobilized were to be made available by LABs for utilization in “local” projects. /wp:list Pursuant to the Budget announcement the Rural Planning and Credit Department of RBI brought out the Guidelines for Setting up of LABs in August 1996.The minimum paid-up capital for an LAB was fixed at Rs.5 crore. These banks could operate in a maximum of three geographically contiguous districts.LABs were to be subject to RBI’s prudential norms, accounting policies and other policies. Following the introduction of the LAB Scheme in Aug-96, five LABs were established during Dec-99 to Feb-01. Subsequently, one closed down in 2004-05, and another converted into a Small Finance Bankin 2016-17. At March-end 2020, there were three LABs. However, in December 2020, RBI cancelled the banking licence of another LAB. Thus, at present, there are only two functioning LABs, namely, Coastal Local Area Bank Ltd.,Andhra Pradesh and  Krishna Bhima SamruddhiLocal Area Bank Ltd., Telangana. All the LABs have been non-Scheduled commercial banks, i.e., banks which are not listed under the Second Schedule of the Reserve Bank of India Act, 1934. Finances of LABs At March-end 2020, the then three LABs had a combined asset of Rs. 1,026 crore, deposits of Rs. 813.8 crore and advances of Rs. 660.5 crore. Thus, the credit-deposit ratio worked out to beas high as 81.1%. During 2019-20, the three LABs witnessed moderate rise in interest income due to the prevailing soft interest rate regime. As against this, non-interest income rose visibly following business diversification. Higher increase in income compared to expenditure improved their profits. Future of LABs Some of the infirmities of LABs are, no doubt, in-born. They do not have freedom to expand business even after fully exploiting the ‘local’ potential, which constrains their revenue models. Focussing on 2-3 districts does not enable them to diversify their risks. Any ‘local’ shock may easily topple their fortunes. The future of LABs is contingent upon what the regulatory authorities think about these entities. In this context, it is pertinent to look at the perceptions of three high-level committees. First, the Report of the High Level Committee on Financial Sector Reforms (September 2008), (Chairman: Dr. Raghuram G Rajan) described LAB as an “experiment” and was dismayed at why the experiment was discontinued although there was no “catastrophic failure.” Second, the RBI Discussion Paper “Banking Structure in India - The Way Forward” (August 2013), though finds weaknesses in LAB model, suggests that some urban cooperative banks can be converted into LABs or small banks. Third, the RBI Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (Chairman: Dr. Nachiket Mor) (December 2013) recommends an array of specialized institutions to cater to the myriad emerging needs of various sections of the population. LABs could fit into one of those institutions. Concluding Remarks There is a case for RBI to consider designating LABs as “Scheduled Banks” (i.e., banks listed in the Second Schedule of the Reserve Bank of India Act, 1934). LABs satisfy the two fundamental criteria laid down vide Section 42 (6) (a) of the Reserve Bank of India Act, 1934 for a bank to become eligible to be listed in the Second Schedule of the Act. The criteria are:  (i) The bank has a paid-up capital and reserves of an aggregate value of not less than five lakhs of rupees and (ii) The bank satisfies RBI that its affairs are not being conducted in a manner detrimental to the interests of its depositors. LABs are basically small banks and the traditional debate on small banks versus large banks is an undying one, whether in India or any other country. Therefore, a conscious decision by consensus has to be taken by both RBI and the government as to whether more LABs or similar small banks should be permitted to enter the turf or not. Binding the small banks, ab initio, to a limited area reflects an overly cautious approach; rather there should be flexibility in the form of linking expansion to performance. There should be optimum trade-off between regulatory strictness and freedom given to small banks. About the Author: Dr. Manas R. Das is a former senior economist of State Bank of India. He has over 30 years of experience as an economist in two large commercial banks. Academically, he is a gold medalist in Bachelor of Arts with Economics Honours from Utkal University, followed by Master’s in Economics from Delhi School of Economics and Doctorate in Economics from Gokhale Institute of Politics and Economics. He is also a Certified Associate of the Indian Institute of Bankers. He has won several awards, besides being a prolific writer.