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Bank licences for corporates: RBI group ignored advice of experts

Rajan, Acharya said that the proposal to let industrial houses into banking will lead to “connected lending” which, according to them, is "invariably disastrous" and would further “exacerbate the concentration of economic (and political) power in certain business houses”.

By: ENS Economic Bureau | New Delhi | Updated: November 24, 2020 8:34:39 am
Raghuram Rajan and Viral AcharyaFormer RBI Governor Raghuram Rajan and ex-Deputy Governor Viral Acharya.

IN ITS proposal recommending entry of business houses into the banking sector, the Reserve Bank of India’s Internal Working Group (IWG) ignored the advice of financial experts it consulted.

On Monday, former Reserve Bank Governor Raghuram Rajan and ex-Deputy Governor Viral Acharya criticised the proposal, saying that all the experts consulted by the IWG except one “were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank”. “Yet it recommends change,” they said, in a note posted on Rajan’s Linkedin site.

The two said that the proposal to let industrial houses into banking will lead to “connected lending” which, according to them, is “invariably disastrous” and would further “exacerbate the concentration of economic (and political) power in certain business houses”.

The IWG, which released its report last week, admitted that “all the experts except one were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank”. The experts consulted by the IWG included Bahram Vakil (Partner, AZB & Partners), Abizer Diwanji (Partner, EY India), Sanjay Nayar (CEO, KKR India), Uday Kotak (MD & CEO, Kotak Mahindra Bank), Chandra Shekhar Ghosh (MD & CEO, Bandhan Bank), and P N Vasudevan (MD & CEO, Equitas Small Finance Bank).

The IWG also consulted experts like former Deputy Governors Shyamala Gopinath, Usha Thorat, Anand Sinha and N S Vishwanathan “for sharing their deep insights with the group”.

In an annexure to its proposal, the IWG, headed by P K Mohanty, noted the objections raised by experts, including that a business house’s non-financial activity may spill over to its bank. “The corporate houses may either provide undue credit to their own businesses or may favour lending to their close business associates. They may influence lending by the bank, to finance the supply and distribution chains and customers of the group’s non-financial businesses, thereby creating unreported risk to the bank,” it said.

The annexure noted that with the prevailing governance culture in corporate houses not up to standard, “it will be difficult to ring fence the non-financial activities of the promoters with that of the bank”.

The note added, “There are various ways of circumventing the regulations on connected lending and due to complex structures of entities, cross holding of capital, the disbursal/diversion of funds to group concerns is difficult to check… It is difficult to prevent influence of corporate houses on the Board in such banks. Assessing ‘fit and proper’ status of the promoters and its large number of group entities is very difficult.”

In their note, Rajan and Acharya said, “Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses… That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism.”

Rajan and Acharya said, “The rationales for not allowing industrial houses into banking are then primarily two. First, industrial houses need financing, and they can get it easily, with no questions asked, 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?” The second reason to prohibit corporate entry into banking was further concentration of power in certain business houses, they said.

The two noted that even an independent regulator finds it difficult to check poor lending. “Can the regulator not discriminate between ‘fit and proper’ businesses and shady ones? It can, but it has to be truly independent, with a thoroughly apolitical board. Whether these conditions will always pertain is debatable. Moreover, once the bank license is given, the licensee’s temptation will be to misuse it because of self-lending opportunities.”

India has seen a number of promoters who passed a fit and proper test at the time of licensing but later turned rogue, Rajan and Acharya said. “The bailout costs to the exchequer could be significantly more when it comes to bank licenses to industrial houses, which will start out big. Why is there urgency to change the regulation? After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?”

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