Former RBI Governor Raghuram Rajan, former DG Viral Acharya say IWG’s recommendation is best left on the shelf at this juncture
New Delhi: The RBI working group’s proposal to allow corporate houses to set up banks is a “bombshell” and at this juncture, it is important to stick to the tried and tested limits on involvement of business houses in the banking sector, according to an article jointly written by former RBI Governor Raghuram Rajan and ex-Deputy Governor Viral Acharya.
They also said that the proposal is “best left on the shelf”.
<“The history of connected lending is invariably disastrous — how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending,” the article said.
Last week, an Internal Working Group (IWG) set up by the Reserve Bank of India (RBI) made various recommendations, including that a large corporate may be permitted to promote banks only after necessary amendments to the Banking Regulation Act. The IWG was set up to review extant ownership guidelines and corporate structure for Indian private sector banks.
Referring to the group’s proposal to allow Indian corporate houses into banking, the article said, “its most important recommendation, couched amidst a number of largely technical regulatory rationalisations, is a bombshell”.
“It proposes to allow Indian corporate houses into banking. While the proposal is tempered with many caveats, it raises an important question: Why now?,” the article said.
The article — posted on Rajan’s LinkedIn profile on Monday — noted that the IWG has suggested significant amendments to the Banking Regulation Act of 1949, aimed at increasing the RBI’s powers, before allowing corporates houses into banking.
“Yet if sound regulation and supervision were only a matter of legislation, India would not have an NPA problem. It is hard not to see these proposed amendments as a subtle way for the IWG to undercut a recommendation it may have had little power over.
“In sum, many of the technical rationalisations proposed by the IWG are worth adopting, while its main recommendation — to allow Indian corporate houses into banking — is best left on the shelf,” they opined.
“Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking,” the article said.
Further, Rajan and Acharya said that as in many parts of the world, banks in India are rarely allowed to fail — the recent rescue of Yes Bank and of Lakshmi Vilas Bank are examples. For this reason, depositors in scheduled banks know their money is safe, which then makes it easy for banks to access a large volume of depositor funds.
They noted that the rationales for not allowing industrial houses into banking are then primarily two. First, industrial houses need financing, and they can get it easily, with no questions asked, if they have an in-house bank.
The second reason to prohibit corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses.
“Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses,” they said.
Rajan is currently Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago Booth School of Business and Acharya is a professor at the Stern School. Both of them are based in the US.
S&P Global Ratings on Monday expressed scepticism over allowing corporate ownership in banks given India’s weak corporate governance amid large corporate defaults over the past few years.
“We are, however, sceptical of allowing corporate ownership in banks given India’s weak corporate governance amid large corporate defaults over the past few years,” S&P said in a statement.
In addition, the RBI will face challenges in supervising nonfinancial sector entities and supervisory resources could be further strained at a time when the health of India’s financial sector is weak, it added.
“In our view, the working group’s concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks. Corporate ownership of banks raises the risk of intergroup lending, diversion of funds, and reputational exposure. Also, the risk of contagion from corporate defaults to the financial sector increases significantly,” S&P said.
At a time when bank failures are increasing in India, the decision to distribute licenses could be controversial.
As per a report by Macquarie Research, the RBI just released an internal working group (IWG) report to review ownership guidelines and corporate structure for private sector banks.
“While the arguably bold recommendations suggest NBFCs as well as corporate houses could apply for a banking license, we believe the possibility of them being granted is very remote”, the report said.
The timing of this report is quite surprising, coming amidst a spate of bank failures. “At a time when bank failures are increasing in India, the decision to distribute licenses could be controversial, in our view. We expect RBI to exercise caution in this regard and hence some recommendations may not come to fruition”, the report added.
For example, the Nayak Committee in May 2014 suggested that a class of investors called Authorised Bank Investors (ABI) be allowed to hold a 20 per cent stake in private sector banks without any regulatory approval. The recommendations of that committee were never implemented.
“By the same token, we don’t believe industrial houses, even if they own NBFCs, will be allowed to open a bank or convert into a bank. The experience of allowing corporate houses to run banks has been pretty bad for RBI (eg: Times Bank, Bank of Rajasthan, etc) and thus, we do not believe RBI will grant licences to corporate houses. Note, on-tap licensing is currently available but RBI has not issued any licences,” the report said.
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