Banking on industrial houses isn’t a bad idea

The recent report of the RBI Internal Working Group (IWG) to review ownership guidelines and corporate structure of private sector banks has generated enough and more discussion and debate. These essentially revolve around the suggestions to allow industrial houses to promote banks, and large NBFCs to convert into banks.

The subject is not new, but the situation has changed since it was last debated. It is also important to discuss it in the context of YES Bank and Lakshmi Vilas Bank episodes. The key issue is how to prevent such episodes from happening.

The report has to be read with RBI’s discussion paper of June 2020 on ‘Governance in Commercial Banks in India’. Only then can one comprehend the overall context of why it is now relevant to allow industrial houses to set up banks in India.

Problem statement

The Indian banking system has been plagued over the years by indiscriminate lending and poor governance standards resulting in bludgeoning non-performing assets and inadequate capital. The gross NPA of the banking system now stands at a whopping ₹10.35 lakh crore. It is no surprise that out of 34 banks in India only State Bank of India features in the top 100 global banks. .

The two reports, for the first time, look at the issues with a 360 degree framework. There are no two opinions that we not only need more banks but bigger and better ones. The least that the public expects from the banking system is safety and security of the deposits. The recommendation of the IWG is that large corporates/industrial houses may be permitted to promote banks only after all safeguards are met and necessary amendments are made to the Banking Regulations Act 1949.

Soon after the suggestion was made, there has been a hue and cry in many quarters that it will result in doomsday for banking. Is it fair to conclude that allowing a large industrial house to start a bank will automatically lead to conflict of interest and governance risks? There are enough cases on hand to establish that standalone banks not forming part of any industrial house have been guilty of faulty lending and poor governance.

It is a fact that 70 per cent of commercial transactions in India are related-party/ connected and that by itself cannot make them mala fide . There are enough provisions in the existing regulations to deal with related- and connected-party transactions and a professional set of directors on the boards of companies are duty-bound to look into these with a fine-tooth comb.

Interestingly, bulk of the NPA in the banking system is not relatable to connected/related-party transactions. Here again it boils down to the rigour of the appraisal system and vigilant oversight of the board.

International experience

The IWG report does point out that several countries like the US, Australia, South Korea, the Philippines, Indonesia and Malaysia do have limits on shareholding by non-financial firms, including industrial houses in banks. Separation of banking and commerce is a practice prevalent in the US and is a subject of constant debate. There are specific provisions in the Federal Reserve Act on regulating relations with affiliates. But then these are countries with their own economic problems and capital structure.

India has to find its own solution to the never-ending problem scarcity of capital and come up with prescriptions in tune with ‘Make in India’, ‘Make for India’ and Atmanirbhar initiatives as the basis of the next phase of development and growth.

The prescription

The answer lies not in preventing industrial houses from setting up banks, but in allowing them with rigours checks and balances. Regulations have to the right and punishments have to be swift. It is here that the RBI’s governance paper of June comes as a good reference point. Various aspects of risk management, process of appointment of whole-time directors and CEO of banks and fixing their tenure, strengthening internal audit and compliance, building a robust system of governance practice, etc., have been discussed.

The sooner these are put into practice the better it will be for the banking industry. This alone will ensure success of the banking business on a long-term basis. Also, the RBI can nominate one director on the board, and also lay down the criteria for appointing independent directors. The chairman of the board can be only an independent director. The tenure of all directors can be fixed and a robust policy of rotation of key management personnel also prescribed.

The next five years are crucial, and we need to jettison some notions of the past to realign ourselves for the future. With technology making major inroads into the banking space, there’s a need to leverage it and improve the process of lending and standards of governance.

Industrial houses having enough capital should be permitted to set up banks, but with all the safeguards provided in the regulations. To start with, they can take up, say, 26 per cent stake in public sector banks. The government can also keep at least 26 per cent holding, providing assurance to the public and depositors.

As rightly pointed out in para 1.3 Chapter 1 of the Report, “In alignment with the agenda set for the economic growth of the country to become a $5 trillion dollar economy, there are heightened expectations for the banking sector to scale up for a greater play in the global financial system.”

To achieve this, what is required is not just incremental steps but a radical shift in thinking.

The writers are chartered accountants

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