Former Reserve Bank of India (RBI) Governor Raghuram Rajan and former Deputy Governor Viral Acharya have stoutly opposed a RBI panel’s recommendation that large corporate/industrial houses be allowed as promoters of banks.
Corporate entry into banking could lead to connected lending and exacerbate the concentration of economic (and political) power in certain business houses, they warned in an article posted by Rajan on LinkedIn.
The main recommendation — to allow Indian corporate houses into banking — of the RBI’s “Internal Working Group (IWG) to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks”is best left on the shelf,” said Rajan and Acharya.
The authors said couched amidst a number of largely technical regulatory rationalisations, is a bombshell: it proposes to allow Indian corporate houses into banking.
“While the proposal is tempered with many caveats, it raises an important question: Why now? Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no,” they opined.
Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking, emphasised Rajan and Acharya.
“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 second reason to prohibit corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses,” the authors said.
Connected lending
Rajan and Acharya observed that the history of connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower?
They underscored that: “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. Information on loan performance is rarely timely or accurate. Yes Bank managed to conceal its weak exposures for considerable periods.”
Authoritarian cronyism
Moreover, regulators can succumb to either political pressure or the urgency of the moment, they added.
“Moreover, as the IWG suggests, it is always difficult to discern the connections that make a borrowing entity part of an industrial house. Some favoured ones are expanding merrily, financing asset purchases with yet more borrowing, imposing greater risks on the system,” the authors said.
Rajan and Acharya are of the view that 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,” they said.
Temptation to misuse
Both Rajan and Acharya felt that 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 turn rogue, they 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,” cautioned the authors.
“Interestingly, the IWG reports in its appendix that all the experts it consulted 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.
Referring to RBI already allowing business houses that don’t have more than a certain fraction of their business in non-financial enterprises to apply for a bank license, the authors asked: “Why not encourage more of these less-conflicted houses to apply for a license?”
Further, RBI also allows business houses to apply for a payment bank license. This allows telecoms and possibly internet platforms to offer deposit accounts.
Rajan and Acharya reasoned: “If they (payment banks) want to make retail loans, they can tie up with a bank, and share any resulting profits. Why again do we need industrial houses to get full-fledged bank licenses? More important, why now, at a time when we are still trying to learn the lessons from failures like IL&FS and Yes Bank? One possibility is that the government wants to expand the set of bidders when it finally turns to privatizing some of our public sector banks (PSBs).”
The authors said it would be a mistake to sell a PSB to an untested industrial house.
They recommended that it is far better to professionalize PSB governance, and sell stakes to the broader public – that would help promote a shareholder culture, as well as distribute wealth more widely.
This could be coupled with some large stakes sold to financial institutions, who can bring governance, as well as financial and technological expertise to the bank.
It would be “penny wise pound foolish” to replace the poor governance under the present structure of these banks with a highly conflicted structure of ownership by industrial houses, they added.
“A second possibility is that an industrial house holding a payment bank license wants to transform into a bank,” said Rajan and Acharya.
“One recommendation of the IWG that is equally hard to understand is to shorten the time for such transformation from five to three years, so perhaps the surprising recommendations have to be read together,” Rajan and Acharya said.