Why Now? Ask Rajan And Acharya On Suggestion To Let Corporates Promote Banks
Raghuram Rajan and Viral Acharya warn against corporate entry into banking, advise the RBI to stick to its current norms.
Former Reserve Bank of India Governor Raghuram Rajan and Deputy Governor Viral Acharya flagged the timing of the central bank-formed internal working group’s recommendation to allow large industrial houses and corporates to promote a bank.
“Why now? Have we learnt something which allows us to override all the prior cautions on allowing industrial houses into banking?” according to a joint article by Rajan and Acharya posted on professional networking site LinkedIn.
Such a recommendation is a “bombshell”, and should not be considered, the two former Indian central bankers argued. In fact, it’s even more important now for the regulator to stick to its tried and tested limits on corporate involvement in banking, they said, adding there’s a need to tread this path cautiously, especially at a time the financial system is still learning from the collapse of Infrastructure Leasing & Financial Services and Yes Bank.
The article also asks why is there an urgency to change the regulations governing bank licensing. “After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?” All but one expert who was consulted by the working group warned against allowing corporates entry into the banking system, they said.
The working group—constituted by the central bank to examine and review the extant licensing and regulatory guidelines relating to ownership and control, corporate structure and other related issues—said corporates’ entry into banking should be allowed only after amendments to the Banking Regulation Act and strengthening the supervisory infrastructure of the RBI.
To this, Rajan and Acharya said if sound regulation and supervision were only a matter of legislation, India would never have a bad loan problem. “It’s hard not to see that these proposed amendments as a subtle way for the IWG (internal working group) to undercut a recommendation it may have had little power over.”
Rajan and Acharya listed two reasons why allowing corporates to promote banks could hurt the sector:
A corporate entity can get financing without any questions asked by an in-house bank. According to Rajan and Acharya, even the most independent committed regulator would find it difficult to be in every nook and corner of poor lending decisions. The information shared on failed loans by the Indian banking system is rarely timely or accurate.
The two former central bankers cite the instance of Yes Bank where this information remained concealed for a long period of time. The private lender had to be rescued by the RBI, with the help of funding from larger domestic banks.
Central banks also run the risk of being put under political pressure or urgency of the moment to loosen their grip on the financial sector.
Already the RBI has eased guidelines governing group exposure norms, which were first tightened in 2016. These guidelines had introduced strict caps on bank financing toward business groups as a whole, rather than individual borrower entities. Rajan and Acharya said the RBI’s working group has recognised the fact that it’s difficult to discern the connections between a borrowing entity and an industrial house. This has led to a situation where a few favoured entities have been expanding their businesses, financing asset purchases through borrowing and raising the risk on the financial system.
Concentration Of Power
Allowing large industrial houses to set up banks could also lead to concentration of economic and political power in certain entities, the article said. “Even if the banking licences are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up.”
About the regulator’s ‘fit and proper’ checks, which it conducts before allotting a banking licence, Rajan and Acharya highlighted that in the past there have been instances of promoters turning rogue after receiving the licence, owing to the temptation of self-lending opportunities. “The bailout costs to the exchequer could be significantly more when it comes to bank licences to industrial houses, which will start out big.”
Besides, highly independent business houses with political connections, according to the economist duo, will have the greatest incentive to push for a banking licence. That will increase the importance of money power yet more in Indian politics, and make the country more likely to succumb to “authoritarian cronyism”, they said.
At present, industrial houses can set up a payments bank, which would allow them to provide payments services and get deposits from retail customers. For small value retail loans, these specialised banks can tie up with traditional lenders and share the profit.
“Why again do we need industrial houses to get full fledged banking licences?” asked Rajan and Acharya, as they point out two possible reasons why such a proposal is being pushed for right now.
More Bidders For Public Sector Banks
One of the reasons for such a recommendation to surface would be the government’s need to have more bidders for public sector banks when they are eventually privatized, the duo said, cautioning strongly against such a move.
“It would be penny wise pound foolish to replace the poor governance in these banks under the present structure of these banks with a highly conflicted structure of ownership by industrial houses,” they said.
A much better solution for the government would be to increase public shareholding in these banks and implement a professional governance structure. Stake could also be sold to large financial institutions which could bring the desired governance and technological support for public sector banks.
Benefitting A Chosen Few
Without naming any industrial house, Rajan and Acharya said the recommendation could be emanating from the need of a large industrial house holding a payments bank licence to transform into a universal bank. Among the recommendations, the internal working group suggested reducing the minimum period of operations for a payments bank converting into a small finance bank to three years from five years currently.
“So perhaps the surprising recommendations have to be read together,” they said.
There are many technical recommendations made by the internal working group would be worth adopting, according to the two senior economists, but the specific one relating to corporates’ entry into banking should remain on the shelf.