Banking Licenses to Corporate May not be a Good Idea

Abstract

The recommendations of the Internal Working Group (IWG) of the Reserve Bank of India (RBI) allow the corporate houses to promote banks in India. This will bring in some benefits such as increased lending capacity and development of financial services but a number of problems such as conflict of interest, intergroup lending, fund diversion, corporate governance, financial stability and contagion arising due to corporate default as well as the economic concentration which will lead to increased inequality. 

An internal working group (IWG) of the Reserve Bank of India in its report has recommended that large business groups as well as NBFCs which have an asset size of ₹ 50,000 crores or more may be allowed to promote banks in India (RBI, 2020). For an economy like India which has avoided giving banking licenses to the corporate houses and ensured that the banks in India are widely held and there is no ownership concentration in Indian Banks, the proposed recommendations of IWG are not just sweeping changes in regulatory orientation but may prove revolutionary however with unknown results. This naturally raises many questions regarding the possible consequences as well as the timing. However, considering the needs of the Indian economy at this juncture of time when it requires more investment in the economy (Upadhyay R. , 2019a), any effort to broaden banking services in the country should not be assessed with presumptions even if the idea is unconventional.

A large number of economists including the former RBI Governor Raguram Rajan and the Deputy Governor Viral Acharya have raised questions about this sweeping recommendation as well as its timing (Acharya & Rajan, 2020). It is quite possible that it may prove to be either a good or bad idea for the Indian banking sector but only time can provide the right answers. However, the practices across the world may give insight into the matter as the reason for such a sweeping recommendation has been cited as the international practices. The same document clearly mentions that most of the countries in the world don’t have an explicit cap on the maximum shareholding by an entity or single person (RBI, 2020). In the major developed countries, only Australia has explicit cap limiting the voting rights up to maximum of 20 percent for a single/entity (APRA, 1998). However, on the other hand, a country like Canada allows a person or an entity to hold up to 65 percent of shares in small banks.

For a capital starved economy like India, it may prove to be a good decision to bring in more capital which the Indian economy desperately needs at this point of time (Upadhyay R. , 2019a). The entry of big business houses in the banking sector will obviously increase the lending capacity of the banking sector as a whole and accelerate the process of development and penetration of the financial services the way private sector banking and financial institutions have done in the last one and half decades particularly. However it will bring in a number of other problems as well which can substantially increase the risk in the banking sector and this is something which cannot be ignored as Indian banking sector already plagued with many problems relating pilling up NPAs, weak corporate governance and lack of transparency in NPAs reporting (Upadhyay R. K., 2019b).

According to the reply of Rajya Sabha Un-starred Question Number 1492 on 18 July 2018, the total amount of bad loans in the country stands at ₹ 9.62 lakh crores as on 31st March 2018 of which ₹ 7.04 lakh crores belong to industry alone. The share of industry is 73.2%. This fact itself is self-expletory. A careful observation of the lists of wilful defaulters issued by different banks, it is evident that a large number of the biggest defaulters are the big business houses. In the event of wilful defaults, a weak corporate governance structure and culture has been playing a pivotal role along with the poor lending and debt monitoring and restructuring practices followed by the banks. If these key issues of the weak corporate governance culture in corporate houses and poor lending and debt monitoring and restructuring practices of banking institutions are clubbed together, it would pose a far greater risk to the whole banking sector which may result into greater financial stability challenges for the Indian economy.

The historical perspective and the experiences regarding corporate house promoted banks gives some idea. RBI since the last four decades (last round of nationalization of banks in 1980), has not allowed the corporate houses to promote banks in India and this does not seem to be an arbitrary decision. Prior to the nationalization, banks were involved in intergroup lending and the share of the intergroup lending was as high as 25 percent. Another disturbing part of the whole episode is that just 188 individuals served as directors on the boards of 20 leading banks and held 1452 directorships in 1100 companies (Kaul, 2020). It is important to note that the IWG report itself suggests that there is a risk that the Indian banking sector would be exposed to the grave issue of the conflict of interests as the separation between the lenders and borrower would diminish directly in many cases and indirectly in large numbers of cases. Perhaps it is the reason because of which except one, no expert has endorsed this idea.

Apart from the problems of the conflict of interest, intergroup lending and corporate governance post implementation of the recommendations, the banking sector might be exposed to the problems of fund diversion, financial stability as well as the contagion arising from the corporate default. However to some extent the problem of the conflict of interest, intergroup lending and diversion of funds can be checked through prudent regulation and supervision but the problem of financial stability of banking sector and contagion arising from corporate default cannot be avoided at all and these two issues are enough to support the argument which requires the separation of the corporate operations and banking operations; so the ownership. Besides these issues, the Indian economy will also have to face the problem of economic concentration which would lead to higher inequalities in the economy which is already facing the problem of rising inequalities (Upadhyay R. K., 2015). It will as a whole jeopardize the prospects of the economy in the medium to long term by posing grave structural and institutional risks to the economy and democratic political structure of the country. Therefore, it is advised that the government must engage in thorough consultations with experts and tread carefully before diving in the risky territory while not be dissuaded by the negative views for taking bold decisions. However, it would be implemented as a shock treatment to banking sector and economy as was in the case of demonetization (Upadhyay R. K., 2019c).

Bibliography:-

• Acharya, V., & Rajan, R. (2020). Do we really need Indian corporations in banking?
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- Dr. Rajeev Kumar Upadhyay

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