Must Read
Explained: How the catching standards in India-Australia series have droppedBengal: EC releases electoral roll, over 20 lakh names addedAdhir to Mamata: Join Cong to defeat BJP$680 million project afoot to redevelop New Delhi station, Railways woos global investorsAlong the 15-km stretch at Singhu, 50 horsemen trot ‘in R-Day preparation’To avoid jams, Haryana farmers say will start for Delhi on Jan 20Comedian Munawar Faruqui stays in jail, co-accused include brother, friend, organiserNIA summons farm union leader for questioning, he says bid to derail protestKovind gives Rs 5 lakh, Governors & chief ministers too donate for Ram TempleOn farmers, SC flagged no consultation, let it hear us on J&K: Omar AbdullahForm own group to discuss laws: Govt to farmer unions

Corporates as banks: What led to this recommendation, and why has it come in for criticism?

A recent RBI report has recommended that large corporate and industrial houses should be allowed ownership of private banks. What led to this recommendation, and why has it come in for criticism?

The Reserve Bank of India. (File Photo)

A recent report by an Internal Working Group of the Reserve Bank of India has attracted a lot of attention as well as criticism. The IWG was constituted to “review extant ownership guidelines and corporate structure for Indian private sector banks” and submitted its report last week.

The IWG submitted several recommendations, but one, in particular, has raised a lot of concern. This had to do with allowing large corporate/industrial houses to be promoters of private banks.

In a joint write-up published on LinkedIn, former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya severely criticised the suggestion by the IWG, describing it a “bombshell”. “It would be ‘penny wise pound foolish’ to replace the poor governance under the present structure of these (public sector/government-owned) banks with a highly conflicted structure of ownership by industrial houses,” Rajan and Acharya wrote.


Why was the IWG constituted and what were its recommendations?

The banking system in any country is of critical importance for sustaining economic growth. India’s banking system has changed a lot since Independence when banks were owned by the private sector, resulting in a “large concentration of resources in the hands of a few business families”.

To achieve “a wider spread of bank credit, prevent its misuse, direct a larger volume of credit flow to priority sectors and to make it an effective instrument of economic development”, the government resorted to the nationalisation of banks in 1969 (14 banks) and again in 1980 (6 banks).

With economic liberalisation in the early 1990s, the economy’s credit needs grew and private banks re-entered the picture. As Chart 1 shows, this had a salutary impact on credit growth.

However, even after three decades of rapid growth, “the total balance sheet of banks in India still constitutes less than 70 per cent of the GDP, which is much less compared to global peers” such as China, where this ratio is closer to 175%.

Moreover, domestic bank credit to the private sector is just 50% of GDP when in economies such as China, Japan, the US and Korea it is upwards of 150 per cent. In other words, India’s banking system has been struggling to meet the credit demands of a growing economy. There is only one Indian bank in the top 100 banks globally by size. Further, Indian banks are also one of the least cost-efficient.

Also read | Bank licences for corporates: RBI group ignored advice of experts

Clearly, India needs to bolster its banking system if it wants to grow at a fast clip. In this regard, it is crucial to note that public sector banks have been steadily losing ground to private banks as Charts 2, 3 and 4 show. Private banks are not only more efficient and profitable but also have more risk appetite.

It is in this background that the IWG was asked to suggest changes that not only boost private sector banking but also make it safer.

For the most part, the IWG’s recommendations are unexceptionable in that they bolster prudential norms so that the interests of the depositors are secure and banks and their promoters are not able to game the system.

Source: RBI

Why is the recommendation to allow large corporates to float their own banks being criticised?

Historically, RBI has been of the view that the ideal ownership status of banks should promote a balance between efficiency, equity and financial stability.

A greater play of private banks is not without its risks. The global financial crisis of 2008 was a case in point. A predominantly government-owned banking system tends to be more financially stable because of the trust in government as an institution.

Editorial | Open cautiously: Banking sector needs more competition. But allowing corporates in without strong regulation could heighten systemic risk

Moreover, even in private bank ownership, past regulators have preferred it to be well-diversified — that is, no single owner has too much stake.

More specifically, the main concern in allowing large corporates — that is, business houses having total assets of Rs 5,000 crore or more, where the non-financial business of the group accounts for more than 40% in terms of total assets or gross income — to open their own banks is a basic conflict of interest, or more technically, “connected lending”.

Raghuram Rajan and Viral Acharya have severely criticised the suggestion by the IWG, describing it a “bombshell”. (File Photos)

What is connected lending?

Simply put, connected lending refers to a situation where the promoter of a bank is also a borrower and, as such, it is possible for a promoter to channel the depositors’ money into their own ventures.

Connected lending has been happening for a long time and the RBI has been always behind the curve in spotting it. The recent episodes in ICICI Bank, Yes Bank, DHFL etc. were all examples of connected lending. The so-called ever-greening of loans (where one loan after another is extended to enable the borrower to pay back the previous one) is often the starting point of such lending.

Unlike a non-bank finance company or NBFC (many of which are backed by large corporates), a bank accepts deposits from common Indians and that is what makes this riskier.

Simply put, it is prudent to keep the class of borrowers (big companies) apart from the class of lenders (banks). Past examples of such mingling — such as Japan’s Keiretsu and Korea’s Chaebol — came unstuck during the 1998 crisis with disastrous consequences for the broader economy.

In the past, RBI has always frowned upon this suggestion. In fact, when the IWG reached out to its set of experts, it found that barring one, all of them “were of the opinion that large corporate/industrial houses should not be allowed to promote a bank”.

ExplainSpeaking | What is driving Indian economy’s growth worries

Then why recommend it?

The Indian economy, especially the private sector, needs money (credit) to grow. Far from being able to extend credit, the government-owned banks are struggling to contain their non-performing assets.

Government finances were already strained before the Covid crisis. With growth faltering, revenues have plummeted and the government has limited ability to push for growth through the public sector banks.

Large corporates, with deep pockets, are the ones with the financial resources to fund India’s future growth.

Of course, choosing this option is not without serious risks.

Don’t miss from Explained | With Karvy expelled from exchange, what happens to its clients

📣 The Indian Express is now on Telegram. Click here to join our channel (@indianexpress) and stay updated with the latest headlines

For all the latest Explained News, download Indian Express App.

News Assist
Next Story