The RBI internal working group’s suggestion to allow large corporates/industrial houses as promoters of banks is fraught with risks such as connected lending and increase in contagion from corporate default to the financial sector, experts have warned.

While the market appeared upbeat on the prospect of large corporates owning a bank, former RBI Governor Raghuram Rajan, former Deputy Governors Viral Acharya and SS Mundra, and ratings agency S&P Global Ratings, among others, cautioned the central bank about possible repercussions.

Rajan and Acharya, in a joint article posted by the former on LinkedIn, warned that corporate entry into banking could lead to connected lending and exacerbate the concentration of economic (and political) power in certain business houses.

The main recommendation — to allow Indian corporate houses into banking — “is best left on the shelf,” they said.

“Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no... 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 privatising some of our public sector banks (PSBs).”

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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 professionalise PSB governance, and sell stakes to the broader public — that would help promote a shareholder culture, as well as distribute wealth more widely.

“The rationale 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.

Difficult to regulate

SS Mundra, a former RBI Deputy Governor, observed that the RBI working group had itself indicated some concerns in allowing corporate houses to become promoters of banks. “It has indicated that the move should be backed by enabling provisions in the Banking Regulation Act. But even so, it has to be further backed by consolidated regulation/supervision across regulators — SEBI, IRDAI, etc. And this is easier said than done. Most advanced economies have also not been able to say with confidence that regulations can address all the risks.”

He added that the probable argument for allowing corporates is that it can help bring in much needed capital into the system and support credit growth. “But rather than only focussing on bank-led credit growth, time and again, it will be worthwhile to focus on strengthening the bond market, which has remained an unfinished agenda for long,” he added.

S&P sceptical

S&P Global Ratings said it is sceptical about the 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.

“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.

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S&P raises concerns over allowing corporates into banking sector