Former Reserve Bank of India (RBI) governor Raghuram Rajan has cautioned against the entry of industrial houses into banking, arguing it will lead to concentration of economic and political power with certain corporates. This will also make us vulnerable to authoritarian cronyism.
Rajan said that a failed bailout package would be a big cost to the exchequer. Business houses that are highly in debt and politically connected will have the greatest incentive and ability to rush for licences, he added.
"Corporate entry will exacerbate the concentration of economic (and political) power in certain business houses. That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism," Rajan said in a paper co-written with former deputy governor Viral Acharya.
"Why is there urgency to change the regulation?" they asked. This year the RBI had to deal with two bank failures Yes Bank and Lakshmi Vilas Bank, and we barely learnt from the mistakes of IL&FS, the paper stated.
Interestingly, the RBI's internal working group (IWG) reports that all its experts except one "were of the opinion that large corporate/industrial houses should not be allowed to promote a bank".
"Yet it recommends change!" the paper said, adding that the IWG dropped a "bombshell" with this recommendation.
They added, "It is hard not to see these proposed amendments as a subtle way for the IWG to undercut a recommendation it may have had little power over."
If the aim is to bring in more managerial capabilities, the RBI already allows business houses that don't have more than a certain fraction of their business in non-financial enterprises to apply for a bank licence. Why not encourage more of these less-conflicted houses to apply for licences?
As in many parts of the world, banks in India are rarely allowed to fail. Yes Bank managed to conceal its weak exposures for considerable periods. Even an independent regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending. Information on loan performance is rarely timely or accurate.
Even if banking licences are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Can the regulator not discriminate between "fit and proper" businesses and shady ones?
It can, but it has to be truly independent, with a thoroughly apolitical board. Moreover, once the bank licence is given, the licensee's temptation will be to misuse it because of self-lending opportunities. India has seen a number of promoters who passed a fit and proper test at the time of licensing turn rogue. The bailout costs to the exchequer could be significantly more when it comes to bank licences to industrial houses, which will start out big.
India's credit-to-GDP ratio is abysmally low. It is equally true that despite the low level of lending, our banks incur huge loan losses, which ultimately fall on the taxpayer. Is it wise then to induct corporate houses with significant conflicts of interest into banking?
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. It would be a mistake to sell a public-sector bank to an untested industrial house, the paper said. It would be far better to professionalise public-sector bank governance and sell stakes to the broader public—that would help promote a shareholder culture, as well as distribute wealth more widely, the paper said. This could be coupled with some large stakes sold to financial institutions, who can bring governance, as well as financial and technological expertise to the bank.
It would be "penny wise pound foolish" to replace the poor governance under the present structure of these banks with a highly conflicted structure of ownership by industrial houses. A second possibility is that an industrial house holding a payments bank licence wants to transform into a bank. One recommendation of the IWG that is equally hard to understand is to shorten the time for such transformation from five to three years, so perhaps the surprising recommendations have to be read together.
They conclude by saying that many of the technical rationalisations proposed by the IWG are worth adopting, while its main recommendation-to allow Indian corporate houses into banking-is best left on the shelf.
