DH Deciphers | Corporates as bankers: Blessing or blunder?

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The Reserve Bank of India (RBI) recently published the report of its five-member internal working group that was tasked with reviewing the eligibility criteria for bank licensing, examining the preferred corporate structure for banks and reviewing long-term shareholding in banks. The group's several recommendations, particularly allowing large corporate/industrial houses as promoters of banks, have received widespread criticism. Let's dig deeper:

What has the RBI group recommended?

The group says big corporate/industrial houses can be allowed as promoters of banks but only after necessary amendments to the Banking Regulation Act, 1949, to prevent connected lending (=loans given based on connections) and exposures between banks and other financial and non-financial entities of the corporate group concerned. It also proposed that well-run shadow banks (non-banking financial corporations) with an asset size of over Rs 50,000 crore may be considered for conversion into banks if they have been running for 10 years and meet the due diligence criteria.

Don't big corporate houses own banks now?

Since the nationalisation of 14 large private banks in 1969, the RBI has not given banking licences to large corporate houses. Prior to that, most private banks were controlled by big industrial houses in the form of joint-stock companies, which had resulted in rampant connected lending. As promoters of banks, corporate houses used to channel depositors' money (which comes cheap) into their other companies. Even to this day, the RBI doesn't have the powers to prevent connected lending. The 21 private banks operating in India now are owned by financial entities or the public.

Then why allow corporates into the banking sector?

The primary objective is to provide enough capital to banks so that they can lend to businesses in order to boost the economy. Public-sector banks have burnt their fingers with bad loans (remember Vijay Mallya, Nirav Modi, et al?) Since corporations have deep pockets, the move will give a fillip to the banking sector. For example, interest rates on deposits and advances will become more competitive. Many corporates may also take over existing banks, resulting in a lot of churning in the promoter-shareholding of banks.

That sounds great. Why are some people opposing it?

Industrialists are primary debtors in Indian banks. If they start owning banks, that would mean the debtor and the creditor are essentially the same entity. Let's suppose an industrialist is an individual having two pockets. His company is one pocket and the bank that he owns another pocket. When the bank owned by an industrialist lends to his company, it would be putting money from one pocket into another. There's another worry: the pocket that will supply the money will be filled by funds coming from bank depositors (common people like you and me).

There will also be a conflict of interest. Jet Airways and Kingfisher Airlines were once prominent business houses. Imagine the promoters of either company having owned the State Bank of India when they went bankrupt. That would be scary, to say the least. There are fears that allowing corporates into the banking sector will create India's own version of JP Morgan, an American banker-businessman, who used finance to control railroad pricing and stitch together a steel behemoth. But even if the RBI does not go ahead with this specific proposal, corporates will still have a backdoor entry: their shadow banks may be allowed to turn into banks.

What's next? Has the RBI accepted the proposals?

After the fall of YES Bank and the shadow-banking crisis, the RBI has been trying to tighten the regulatory grip on the financial sector — from trying to cap the tenures of promoter CEOs to enforcing stricter compliance guidelines. But in the case of YES Bank, we saw how risky corporate lending could doom a large bank. RBI Governor Shaktikanta Das said on Friday that the central bank had not yet accepted the proposal and would take a decision only after perusing public comments. This would take at least two months.