S&P Global Ratings on Monday said it is sceptical about the Reserve Bank of India (RBI) working group’s recommendations to allow corporate ownership in banks given India's weak corporate governance amid large corporate defaults over the past few years.

The global rating agency underscored that RBI will face challenges in supervising non-financial sector entities and supervisory resources could be further strained at a time when the health of India’s financial sector is weak.

S&P, however, said the working group’s recommendations on awarding new licences to well-managed Indian non-bank financial companies (NBFCs) could improve financial stability.

In the agency’s view, the working group’s concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks.

“Corporate ownership of banks raises the risk of inter-group lending, diversion of funds, and reputational exposure. “Also, the risk of contagion from corporate defaults to the financial sector increases significantly,” S&P said in a statement.

The agency emphasised that the performance of India's corporate sector over the past few years has been weak with large corporate defaults.

Non-performing loans (NPLs) for the corporate sector stood at around 13 per cent of total corporate loans as of March 2020 (around 18 per cent as of March 2018), highlighting the more pronounced risk in India compared with other countries, it added.

Conversion of NBFCs into banks

S&P believes that NBFCs have numerous strengths that will give them a headstart in their entry into banking. These include their existing client bases, distribution networks, brand and risk management systems.

Conversion to a banking entity could provide more stable funding, in particular low cost deposits.

“Still, we don’t expect the competitive banking environment in India to deteriorate with these new licenses. This is because the finance companies that are converting into banks will have huge upfront regulatory costs,” opined the agency.

Finance companies converting into banks will incur additional costs in terms of cash reserve ratio and statutory liquidity ratio requirements; priority sector lending; and adjusting their existing portfolios to reduce concentration in one segment.

Mixed: New Banks performance

The performance of new banks set up in India over the past three decades has been mixed, the agency said.

Of the 14 new universal bank licenses issued by the RBI since 1993, Global Trust Bank and Yes Bank Ltd. had to be bailed out by government-owned banks.

In addition, three banks were eventually acquired by HDFC Bank Ltd, while ICICI Bank Ltd and IDBI Bank Ltd merged with their parents.

“Nevertheless, RBI has adopted a very calibrated approach in awarding new licenses. A change in regulation by itself would not lead to RBI liberally allowing corporates to start a bank. The RBI’s fit and proper criteria for banks give it large latitude in decision-making,” S&P emphasised.

Also, most importantly, it remains to be seen how many of these recommendations become law, it added.