Say ‘no’ to corporate houses in Indian Banking
Paper :
Mains : G.S. III Indian Economy
Context
- An Internal Working Group of the RBI has recommended that corporate houses be given bank licenses.
- In today’s pro-business climate, you would have thought the proposal would evoke great success. It should have been hailed as another big-bang reform that would help revert the dominance of public sector in banking.
- Instead, the reaction has ranged from cautious welcome to sharp criticism.
- Many analysts doubt the proposal will fly. It is worth examining why.
Explanation
- The idea of allowing corporate houses into banking is not new.
- In 2013, the RBI had issued guidelines that permitted corporate and industrial houses to apply for a banking license.
- No corporate was ultimately given a license. Only two entities qualified for a licence, IDFC and Bandhan Financial Services.
- The RBI maintained that it was open to letting in corporates. However, none of the applicants had met ‘fit and proper’ criteria.
- The IWG report quotes the official RBI position on the subject at the time. “At a time when there is public concern about governance, and when it comes to licences for entities that are intimately trusted by the Indian public, this (not giving a license to any corporate house) may well be the most appropriate stance.”
- In 2014, the RBI restored the long-standing prohibition on the entry of corporate houses into banking. The RBI Governor then was Raghuram G. Rajan. Mr. Rajan had headed the Committee on Financial Sector Reforms (2008).
- The Committee had set its face against the entry of corporate houses into banking. It had observed, “The Committee also believes it is premature to allow industrial houses to own
- This prohibition on the ‘banking and commerce’ combine still exists in the United States today, and is certainly necessary in India till private governance and regulatory capacity improve.
- The RBI’s position has remained unchanged in this subject since 2014.
- The Internal Working Group report weighs the pros and cons of letting in corporate houses. Corporate houses will bring capital and expertise to banking.
- The main concerns are interconnected lending, concentration of economic power and exposure of the safety net provided to banks (through guarantee of deposits) to commercial sectors of the economy. It is worth elaborating on these risks.
- Corporate houses can easily turn banks into a source of funds for their own businesses. In addition, they can ensure that funds are directed to their cronies. They can use banks to provide finance to customers and suppliers of their businesses. Adding a bank to a corporate house thus means an increase in concentration of economic power.
- Just as politicians have used banks to further their political interests, so also will corporate houses be tempted to use banks set up by them to enhance their clout.
- The Internal Working Group believes that before corporate houses are allowed to enter banking, the RBI must be equipped with a legal framework to deal with interconnected lending and a mechanism to effectively supervise conglomerates that venture into banking.
- Tracing interconnected lending will be a challenge. Monitoring of transactions of corporate houses will require the cooperation of various law enforcement agencies. Corporate houses can use their political clout to thwart such cooperation.
- The RBI can only react to interconnected lending ex-post, that is, after substantial exposure to the entities of the corporate house has happened. It is unlikely to be able to prevent such exposure.
- Pitting the regulator against powerful corporate houses could end up damaging the regulator. The regulator would be under enormous pressure to compromise on regulation. Its credibility would be dented in the process. This would indeed be a tragedy given the stature the RBI enjoys today.
- There are corporate houses that are already present in banking-related activities through ownership of Non-Banking Financial Companies (NBFCs).
- Under the present policy, NBFCs with a successful track record of 10 years are allowed to convert themselves into banks. The Internal Working Group believes that NBFCs owned by corporate houses should be eligible for such conversion. This promises to be an easier route for the entry of corporate houses into banking.
- There is a world of difference between a corporate house owning an NBFC and one owning a bank.
- Bank ownership provides access to a public safety net whereas NBFC ownership does not.
- The real attraction will be the possibility of acquiring public sector banks, whose valuations have been lowered in recent years.
- Public sector banks need capital that the government is unable to provide. The entry of corporate houses, if it happens at all, is thus likely to be a prelude to privatisation.
- India’s banking sector needs reform but corporate houses owning banks hardly qualifies as one.