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Wednesday, January 19, 2022

Explained: Why RBI has kept entry of big businesses in banking on hold for now

Corporate houses were active in the banking sector till five decades ago when the banks promoted by them were nationalised in the late sixties amid allegations of connected lending and misuse of depositors’ money.

Written by George Mathew , Edited by Explained Desk | Mumbai |
Updated: December 9, 2021 2:02:30 pm
RBIOn November 26, the RBI said it has accepted 21 out of 33 recommendations of the IWG on ownership of private banks, but kept silent on giving banking licence to big business groups. (File photo)

The Reserve Bank of India (RBI) has kept in limbo the proposal of its Internal Working Group (IWG) for granting banking licence to big corporate houses amid fears over connected lending and self-dealing if they are allowed in the banking space.

What’s the big worry?

While the main argument in favour of allowing corporate presence in banking is that they can bring in capital, business experience and managerial competence, there are apprehensions that it was not easy for supervisors to prevent or detect self-dealing or connected lending as banks could hide connected party or related party lending behind complex company structures and subsidiaries or through lending to suppliers of promoters and their group companies. These loans can subsequently become bad assets of the bank. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses.

On November 26, the RBI said it has accepted 21 out of 33 recommendations of the IWG on ownership of private banks, but kept silent on giving banking licence to big business groups.

What’s connected lending?

Connected lending involves the controlling owner of a bank giving loans to himself or his related parties and group companies at favourable terms and conditions. Business groups need financing, and they can get it easily with no questions asked if they have an in-house bank. In short, companies can use the bank as a “private pool of readily available funds”. Big business groups already account for a major chunk of non-performing assets (NPAs) in the banking system even without becoming promoters of a bank.

Former Governors’ opposition to the move

When the IWG released its report in November 2020, former RBI Governor Raghuram Rajan and Deputy Governor Viral Acharya opposed the entry of business houses in banking, saying if industrial houses need financing, they can get it easily if they have an in-house bank. “The history of such 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,” they said in a joint article. In August 2011, the then RBI Governor D. Subbarao said in one of his speeches, “by far the biggest apprehension is about self-dealing — that companies will use the bank as a private pool of readily available funds.”

The story so far

Corporate houses were active in the banking sector till five decades ago when the banks promoted by them were nationalised in the late sixties amid allegations of connected lending and misuse of depositors’ money. The sector was opened up again post liberalisation with the first round of licensing of private banks that was done in 1993. Since then, there were two more rounds of licensing of banks in the private sector – in 2003-04 and 2013-14 – culminating with the on-tap licensing regime of universal banks since 2016. However, business houses were not considered though prominent corporates houses including Aditya Birla Group, Anil Ambani’s Reliance Capital and Bajaj group showed interest in 2013-14.

Can industrial groups hold bank stake?

The central bank says individuals and companies, directly or indirectly connected with large industrial houses are permitted to participate in the equity of a new private sector bank up to 10 per cent and should not have controlling interest in the bank. Such shareholders should not have any Director on the board of the bank on account of shareholder agreements or otherwise, the RBI said in its Guidelines for ‘on tap’ Licensing of Universal Banks in the Private Sector issued in August 2016. A group with assets of Rs 5,000 crore or more with the non-financial business of the group accounting for 40 per cent or more in terms of total assets or in terms of gross income, will be treated as a large industrial house, the RBI said.

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