Rural Planning and Credit Department
Local Area Bank Section

New Policy on the working of Local Area Banks

The Local Area Bank Scheme was introduced in August 1996 pursuant to the announcement of the then Finance Minister in his budget speech. Following this, guidelines for setting up of Local Area Banks (LABs) in the private sector were announced by the Reserve Bank on 24^th August 1996.

2.As no comprehensive review of the LAB scheme had been made since the issuance of guidelines in 1996, a Review Group with outside experts was appointed by RBI in July 2002 to study and make recommendations on the LAB Scheme. The Review Group has submitted its Report on 1^st October 2002.

The major policy issues raised by the Review Group pertain to :

1. Discontinuance of the LAB Scheme
2. Increase in capital base of LABs
3. Higher capital adequacy requirement
4. Transfer of regulatory work in respect of LABs to DBOD.

The report of the Review Group was placed on the RBI website on 26^th October 2002 inviting suggestions from different quarters, if any, on the recommendations. The recommendations of the Review Group have been examined by the Department keeping in view of the suggestions received and the same was approved by the Government. The new change in policy in this regard is indicated below:

(i) Licensing of new Local area banks : The Review Group has suggested specific measures to strengthen the existing LABs so that they are placed on sound footing and it has been decided that in future there should be no licensing of new banks.

(ii) Capital base : LABs with their present capital base of Rs 5 crore cannot become viable institutions. The existing LABs should be asked to reach net worth of at least Rs.25 crore over a period of five to seven years for attaining viability.

(iii) Capital adequacy: LABs should maintain a minimum capital adequacy of 15% over a period of next five to seven years. The higher capital adequacy norm is proposed because LABs carry an inherently high risk port-folio and do not have derisking possibilities. The matrix proposed by the R.G. - A net worth of Rs.25 crore and capital adequacy norm of 15% would enable LAB to build an asset base of about Rs.150 crore, a level at which their operations would become viable. The LABs may be required to submit a suitable road map for achieving the twin objectives of higher capital base of Rs 25 crore and capital adequacy of 15% over a period of five to seven years.

(iv) Regulatory arrangements: LABs need to be treated like any other commercial bank and, therefore, regulation should be entrusted to the same wing of the RBI ie DBOD which is responsible for regulation and function of supervision of LABs will continue to be with DBS.