Insight & Analysis

Account rules shake up Indian banking

Published: Aug 2021

New rules on current accounts have taken effect in India, which has caused disruption for some companies as their banks took action to meet the July deadline imposed by the Reserve Bank of India. The new rules are also expected to have an impact on the competitive banking landscape in the country.

Silver balls with red arrows

The first warning that things would change was almost a year ago, but as the deadline approached it seems that not everyone was prepared. The Reserve Bank of India (RBI) issued a circular back in August 2020 entitled ‘Opening of Current Accounts by Banks – Need for Discipline’, which was a move to rein in the misuse of multiple accounts.

Banks were given a few months to streamline the use of current accounts, but the deadline was extended to the end of July 2021. Now, as that deadline has passed, a number of companies have been inconvenienced by the changes – with some having their current accounts blocked or frozen. Local news reports have detailed how some businesses have come to a halt because they are unable to pay suppliers or access their funds.

The RBI rule aims to simplify the use of current accounts by companies so that lenders can have greater visibility of the cash flows of their customers. The idea is to prevent intentional defaults and the ‘diversion of funds’, for example where a company defaults on a loan with one bank – claiming a lack of funds – while receiving payments into multiple operating accounts at other banks.

The rule change means that banks cannot open current accounts for customers who have cash credit or overdraft facilities at other banks in India. Also, the current account has to be held at the bank that is a main lender. If the customer’s credit exposure to the bank is less than 10%, then the current account has to be moved elsewhere. For banks in India, this has proved to be a massive operational challenge, with one news report estimating that a large public sector bank had to close 40,000 such accounts, while State Bank of India had to close approximately 80,000.

The rule change is expected to have a wider impact on the banking industry. Banks have either had to close accounts of their customers, or encourage a larger lending relationship. Meanwhile, companies have had to make choices about who they bank with. Foreign banks are expected to struggle the most in the face of the new rules as they typically have a higher proportion of current accounts, but not the corresponding market share of lending.

It is expected that the large Indian banks will increase their market share and continue a trend of consolidation. According to a report by Coalition Greenwich, the new rules on current accounts are one of the factors that have driven consolidation among Indian banks. The Covid crisis was also given as another reason. The report states that Indian companies have needed to change their cash management providers as a result of the new rules and large private-sector and public Indian banks will be the clear winners. “The new directive has put foreign banks under considerable pressure. Even before the [Reserve Bank of India] circular, foreign banks were finding it more and more difficult to compete with India’s domestic private-sector banks, which are rapidly upgrading capabilities. In addition, their employees are increasingly able to go toe-to-toe with their foreign counterparts, due in large part to the training and experience they received working for foreign banks earlier in their careers,” the report states.

The report also notes that ICICI Bank, Axis Bank and HDFC Bank have steadily been increasing their market share. In 2016, for example, only 17% large and middle market Indian companies banked with at least one of them, and that share had increased to nearly 25% in 2020. Meanwhile, the State Bank of India had maintained its dominant position, with nearly a third of Indian corporates banking with the public bank – both for corporate lending and cash management.

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