Emphasising the need to strengthen existing local area banks to place them on a sound footing, Reserve Bank of India has decided not to issue any new licence for a LAB.

LABs with their present capital base of Rs 5 crore (Rs 50 million) cannot become viable institutions and the existing LABs would be required to reach a net worth of at least Rs 25 crore (Rs 2.5 million) over a period of five to seven years for attaining viability, RBI said in a release in Mumbai on Tuesday.

The apex bank said, as per the recommendations of the review group with former finance secretary G Ramachandran as chairman, LABs should maintain a minimum capital adequacy ratio of 15 per cent.

The higher CAR norm was proposed because LABs carry an inherently high-risk portfolio and do not have derisking possibilities, it said.

A net worth of Rs 25 crore and CAR of 15 per cent would enable a LAB to build an asset base of about Rs 150 crore (Rs 1.5 billion), a level at which their operations would become viable, RBI said.

LABs would also be required to submit a suitable road map for achieving the twin objectives of higher capital base of Rs 25 crore and CAR of 15 per cent, it added.

On regulatory arrangements, the group said LABs need to be treated like any other commercial bank and therefore regulation should be entrusted to the same wing of RBI, which is responsible for regulation and supervision of LABs.

RBI said the review group, which had submitted its report in October 2002, had drawn attention to the weaknesses in the concept of the LAB model, particularly to the size, capital base, inherent inability to absorb losses, which were bound to arise in the course of business, risk prone credit portfolio and inability to diversify and derisk.

The group suggested certain measures, including strengthening of capital base, increase in CAR requirement, prohibition on engagements of agents by LABs for achieving business outreach, prohibition on trading in government securities during their formative years.