Saturday, November 28, 2020

Banking Licenses to Corporate May not be a Good Idea

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 corporate and ensured that the banks in India are widely held and there is no ownership concentration in Indian Banks, the proposed recommendation of IWG is a sweeping change and naturally raising a number of questions. Large numbers of economists including the former RBI Governor Raguram Rajan and Deputy Governor Viral Acharya have raised questions about this sweeping recommendation as well as the timing (Acharya & Rajan, 2020). It is quite possible that it may prove to be either good or bad idea for Indian banking sector but only time can give the right answer. However, the practices across the world may give insight into the matter.

The reason for such a sweeping recommendation has been cited as the international practices. 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 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 Indian economy desperately needs at this point of time. The entry of big business houses in the banking sector will increase the lending capacity of the banking sector as whole and accelerate the development of financial services and its penetration. However it will bring in a number of other problems as well which can substantially increase the risk in the banking sector.

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 is ₹ 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-exploratory. If one observes and studies the lists of wilful defaulters issued by different banks, it is evident that large numbers of the biggest defaulters are big business houses. In these events of wilful defaults, a weak corporate governance structure and culture has played a pivotal role along with the poor lending and debt restructuring practices followed by the banks.

The historical perspective and the experiences regarding corporate house promoted banks gives some idea. RBI since last four decades (last round of nationalization of banks in 1980), has not allowed corporate to promote banks in India and this does seem to be an arbitrary decision. Prior to nationalization banks were involved in intergroup lending and the share of the intergroup lending was high as 25 percent. Also just 188 individuals served as directors on the boards of 20 leading banks and held 1452 directorships in 1100 companies (Kaul, 2020). The IWG report itself suggest that there is risk that 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 in many 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, the banking sector will 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 and this will require separation of corporate operation and banking operation. Besides these, the Indian economy will also have to face the problem of economic concentration which would lead to higher inequalities jeopardizing the economy. Therefore, the government must tread carefully before diving in the risky territory.

Bibliography:-

  • Acharya, V., & Rajan, R. (2020). Do we really need Indian corporations in banking?
  • APRA. (1998). Financial Sector (Shareholdings) Act 1998. Financial Sector (Shareholdings) Act 1998. Retrieved from https://www.legislation.gov.au/Details/C2010C00077
  • Kaul, V. (2020, November 23). Why Large Corporates/Industrial Houses Owning Banks is a Bad Idea. Retrieved from Vivek Kaul: https://vivekkaul.com/2020/11/23/why-large-corporates-industrial-houses-owning-banks-is-a-bad-idea/
  • RBI. (2020). Report of the Internal Working Group to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks. RBI.
- Dr. Rajeev Kumar Upadhyay
 


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