Why arguments against issuing bank licences to industrial houses dont hold
There have been numerous articles cautioning the RBI to not issue bank licences to industrial houses. Essentially,four arguments have been made. The first argument is that allowing industrial houses to own banks goes back to pre-World War II Japan and its Zaibatsu system. Since then,there has been a firm Washington Consensus to deny industrial houses bank licences and permit only banks with dispersed share-holding,such as those that exist in the US and UK. The fear is that industrial houses will use depositor money to fund their enterprises,creating big risks for depositors. The second argument is the assertion that the RBI is a weak regulator. Till date,the RBI has never been accused of being a venal institution,and this is because it does not have to deal with real India. The argument runs,true there are worthy industrial houses that could be given bank licences,but the RBI does not or will not have the autonomy or strength to deny the unworthy industrial houses bank licences and so,in balance,it should give none of them a licence.
The third argument is a bit different. It states that India does not need new banks,just bigger banks and a privatisation of its state banks. The sector is currently hampered by the existence of state-owned banks that are inefficient and hamper financial deepening. Finally,a new fourth argument has been made: Elections are around the corner,and political parties will use the issue of bank licences to collect money from potential candidates,like alleged in the telecom sector,with the allocation of spectrum. So,the RBI should be wary and not issue new bank licences to avoid a controversy at this time. Thus,do not issue bank licences and if you do,certainly not to industrial groups.
Let me challenge each of these arguments individually and then close with a broader,collective comment. While much attention is being given to the Japanese experience and the possibilities of depositor fund diversion,there is not much discussion of the recent global financial crisis. The Anglo-Saxon model,with dispersed bank ownership,which is being held up as a role model,caused one of the greatest financial crises in human history,from which the world is yet to recover. In fact,between 1985 and 2007,the financial sector in the US increased its share of corporate profits from 15 per cent to 44 per cent,out-lobbying anything that stood in its way regulators,Congress,the US government,academics,credit rating agencies and earned the most egregious private profits while impoverishing the world. All the big US banks,like Citigroup,Bank of America and Wells Fargo,went bust. The taxpayer was asked to bail them out. Much of the rest of the world allows industrial groups to promote banks,even Canada,whose banks were unaffected by the crisis. Further,the current RBI guidelines prohibit inter-group transactions anyway.
The second argument is that the RBI cannot stand up to industrial houses,so it should not licence them. Somehow,no one talks about the non-bank financial companies (NBFC) sector that the RBI regulates. Many of the biggest NBFCs are owned by industrial houses. Over the past few years,the NBFCs have been complaining about the tightness of RBI regulations and have not been able to get much relief. But the belief is that when NBFCs become banks,where the RBI has much broader powers of regulation,it will suddenly get weak in the knees and cave in to their every misdemeanour.
The third argument,which at one time people believed had been the RBIs internal position,was that India does not need new banks. It just needs bigger banks and more branches. Empirically,since new banks were given licences in 1994,the sector has undergone a profound transformation. New private banks spurred a massive improvement in the operations of the entire sector,including public sector banks. Today,not only does Indias banking sector have one of the lowest cost-income ratios of 45,its debt equity (not CRAR) ratio of 12 to 1 is low,and return on assets of close to 1 per cent is higher than many parts of Europe,UK and the US. This is not to say that we dont need bigger banks,but just that we must avoid the creation of clubby environments that allow enormous gains to the incumbents at the expense of the retail customer. We need more banks,new banks,big banks and across ownership forms,but all under a strong regulatory umbrella.
A recent last point that has been made is to avoid issuing licences just before an election,because the need for electoral funding will compromise the review process. I have written elsewhere about the need for India to sort out election funding. We cannot prize our democracy without paying for it. Currently,we dont. That is why,as election costs and the price of running political parties has risen,the need for money has gone up and all deals involving land,spectrum,mineral rights,etc are getting compromised. The issuance of bank licences by the RBI was not mired in controversy in the past. This time around,it has made its guidelines clear,tough and even unpopular,and created a process that is fairly transparent,so if there is one place where corruption is less likely,it is here. But more broadly,just because we have a democracy that has not worked out election funding,do we stop taking all important decisions in India? If we do,we will continue to be in the funk that we are in today.
The need in India is to increase access to financial services for about half our population,which is currently excluded. There is also a need to encourage innovation in banking using technology and new forms of partnership. New banks allow us to challenge the existing paradigm. Let nothing come in the way of national interest certainly not vested interests.
The writer is chairman,Asia Pacific,Boston Consulting Group. Views are personal
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