Explained Ideas: Why permitting large industrial houses to own banks is a bad idea

An Internal Working Group of the RBI has recently made a far-reaching recommendation: To permit industrial houses to own and control banks.

Reacting to it, two former chief economic advisors — Shankar Acharya and Arvind Subramanian — as well as a former finance secretary — Vijay Kelkar — have jointly written an opinion piece in The Indian Express stating: “We believe that this step would be a grievous mistake, one that would seriously set back Indian economic and political development. Accordingly, we urge that this proposal be shelved”.

Express Illustration: C R Sasikumar

Why do they have such serious misgivings?

One clue is given in the report itself, which acknowledges that it ignored the experts the group had consulted. The report states that all the experts except one “were of the opinion that large corporate/industrial houses should not be allowed to promote a bank”.

According to the report, the main benefit is that industry-owned banks would increase the supply of credit, which is low and growing slowly.

In response, the three authors state: “Credit constraints are indeed a real problem, and creating more banks is certainly one way of addressing the issue. But this is an argument for encouraging more banks and more types of financial institutions, generally. It is not an argument for creating banks specifically owned by industry. The other powerful way to promote more good quality credit is to undertake serious reforms of the public sector banks.” 📣 Click to follow Express Explained on Telegram

The problem with banks owned by corporate houses is that they tend to engage in connected lending. This can lead to three main adverse outcomes: Over-financing of risky activities; encouraging inefficiency by delaying or prolonging exit; and entrenching dominance. In their opinion piece, the authors provide a detailed explanation of each outcome.

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For more than a quarter of a century, Indian financial sector reforms have aimed at improving not just the quantity, but also the quality of credit. “If India now starts granting banking licences to powerful, politically connected industrial houses, allowing them to determine how credit is al- located, we will effectively be abandoning that long-held objective,” they state.