Corporate banks need not be a ‘bombshell’

The recent report of the Internal Working Group (IWG) of the Reserve Bank of India appears to have sent shock waves amongst some banking watchers and leaders, notably former RBI Governor and Deputy Governor Raghuram Rajan and Viral Acharya, who have termed it a ‘bombshell’. Other credible voices have also joined the chorus .The cause of this alarm was the recommendation of the IWG that corporate houses could be given licences to ‘own’ banks.

While some of the arguments against the recommendation are understandable, most of the concerns appear to be founded on a genetic mistrust of big business, in general, and curiously, on the seemingly incurable limitations of the regulator’s capacity and independence. More than the merits or demerits of the particular proposal, these underlying axioms are problematic.

The first argument is that industrial houses could get finance ‘easily, with no questions asked, if they have an in house bank’, the first assumption of this argument being that the big industrial houses would naturally manipulate the system to enrich themselves, at the expense of other stakeholders. Unfortunately, this betrays a certain assumed character of industrial houses, in general, and big industrial houses (who, admittedly, would be the only ones to pass muster to start a bank), in particular, much like painting a race or a caste with the same brush. This political racism informed the many regulations that stymied the growth of business, and therefore the economy during the first four decades post Independence.

There are enough corporate houses in India which practice high standards of governance and, equally, plenty of examples in the very recent banking history of both ‘professionally managed’ private as well as public sector banks which have succumbed to the greed and dishonesty of individuals leading the banks, with grievous consequences to shareholders and depositors.

Need for better regulation

Even if one were to assume that individual dishonesty is an aberration, but corporate dishonesty is the rule and embrace the Left wing doctrine that the very nature of big business is incurably evil, history of economic development has unambiguously shown that success lies not in caging big business, but effectively taming the beast to do the bidding for the common good. And, hence, the critical need for well designed independent regulators.

This is where the second assumption of the first argument, that ‘regulators can succumb to either political pressure or urgency of the moment’, gets troublesome. If such is the vulnerability of the regulators, the banking system cannot be saved by merely prohibiting Big Business ownership of banks; the bigger risk is with the potential manipulation of public sector banks by the Big Government. If the regulatory fences are snapping or sagging all across the perimeter, because of political interference or weak leadership, nothing much will be saved by locking the gates.

An independent and effective regulator, a strong fence and a tight watch, are fundamental requisites for the entire banking industry, and therefore the economy.

Big business’s misuse of resources of in house banks was indeed the ostensible reason for bank nationalisation in 1969. Regulations have grown in scope and efficacy in the 50 years since. The RBI is today one of the most effective and prudent regulators in the world, thanks to several outstanding leaders, who helmed the institution over the years.

Despite this impressive record, there have indeed been a series of mishaps in the banking sector in recent times, which hold out lessons to further improve oversight. Those improvements should encompass both the design of the control framework as well as the quality of implementation.

There are already specific restrictions against any kind of credit arrangements with companies, in which directors are associated. But it has been argued that cronies of corporates will escape this restrictions, as there will be no formal and visible links with the corporate houses that own the bank. This is a very valid argument, but the situation is no different with political cronies or non-visible associates of unscrupulous leaders of private banks.

An effective oversight framework to monitor credit quality and risk measurement is perfectly feasible, with the use of technology tools, without taking away the independence of the bank management. Indeed, the IWG has made several recommendations with regard to the conditions to be imposed for grant of a licence to a corporate house, which need further study.

The second argument is that granting of banking licences to corporate houses will ‘further exacerbate the concentration of economic (and political) power in certain business houses’.

The free market economic ideology has always run this risk of manipulative big businesses, which initially grow on the basis of market competitiveness, and thereafter display a propensity to consolidate growth through aggrandisement, born out of size and power.

The classic safeguards are obviously appropriate legislation to protect the interest of the consumer, and market regulators to check misuse of power.

In the case of banks part owned by corporates, they are unlikely to be dominant players in the banking field, particularly because public sector banks occupy nearly 70 per cent of the space. Besides, the RBI will have many weapons in the arsenal to check the misuse of banking power for any other pursuits.

While all these regulations can be designed to address the economic fallout of the potential problem of dominant corporates, there are, and can be, no economic policy answers to the political clout of big businesses.

Sentinels of democracy

Those answers can only come from the space available in a functioning democracy through the sentinels of democracy, such as a strong Opposition, an independent judiciary and a free press, and of course, ultimately through people power. It would be somewhat naïve to use a banking policy instrument to checkmate a political powerhouse, which would be rather like denying a giant the use of a club, with the hope to contain his power.

The third argument is that there is no urgency to liberalise the licence policy, although the need for growth of banking sector is not being contested. After all, it’s difficult to argue whether the tepid growth in credit witnessed in the last couple of years is because of slowing economic growth or the other way around.

Given the low banking penetration, there is indeed a compelling need to increase banking supply. Yet, there is some speculation that the IWG report is not an entirely objective exercise, that there might be an agenda to benefit some specific business houses. The dots, some visible, some not so, are being connected. It might well be the case that someone not ‘fit and proper’ might be the beneficiary. If it were indeed so, the policy to licence corporate houses is not the appropriate battleground. The right war theatre is bigger and beyond.

An independent and effective regulator is the only protection against any misuse of institutional power. A free press and a strong opposition are the only guarantors of democracy. Those are the larger concerns.

The writer is Executive Vice-Chairman, Hinduja Group

COMMENT NOW