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Rajan, Acharya hit out at idea of corporates in banking, say borrowers shouldn’t own banks

In a paper, Raghuram Rajan & Viral Acharya have termed the recent recommendation of an RBI internal working group on allowing corporates into banking a ‘bombshell’. 

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New Delhi: Allowing Indian corporate houses into banking will lead to the concentration of economic and political power in these business houses and the exchequer could be faced with significantly higher bailout costs if these banks were to fail, former Reserve Bank of India (RBI) governor Raghuram Rajan and former RBI deputy governor Viral Acharya have said in a paper. 

The paper, posted by Rajan on his LinkedIn page Monday, termed the recent recommendation of an RBI internal working group on allowing corporates into banking a “bombshell” and said this proposal is “best left on the shelf”.

Last week, the RBI released the report of an internal working group on ownership guidelines and corporate structure for Indian private sector banks. The group was tasked to review, among other things, the eligibility criteria for individuals and entities to apply for a banking licence. 

Reacting to this report, Acharya and Rajan wrote that it is even more important in today’s times to stick to the tried-and-tested limits on corporate involvement in banking. 

They pointed out that if industrial houses need financing, they can get it easily, no questions asked, if they have an in-house bank. 

“The history of such connected lending is invariably disastrous — how can the bank make good loans when it is owned by the borrower? Even an independent committed 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. Yes Bank managed to conceal its weak exposures for considerable periods,” they said. 

Allowing the entry of corporates into banking will mean that highly indebted and politically connected business houses will have the greatest incentive and ability to push for licences, they added. 

“That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism. 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,” they added. “Whether these conditions will always pertain is debatable.”


Also Read: Banks have not signed a single agreement for RBI’s debt recast scheme for high value loans


‘Penny wise pound foolish’

In 2016, the paper notes, the RBI had recognised the risk of excessive exposures to specific houses and announced group exposure norms that limit the exposure the banking system can have to specific industrial houses. “These norms have been relaxed recently,” the paper states. 

The internal working group report itself points out that all but one of the experts it consulted were of the opinion “that large corporate/industrial houses should not be allowed to promote a bank”, the authors stated. 

Acharya and Rajan also pointed out that even if promoters pass the criteria at the time of the licence being granted, they can turn rogue later, saying India had witnessed such instances. 

“…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,” they said.  

The two also questioned the timing of the proposal as well as the reasons for the urgency. 

“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, as we have said in an earlier paper, to sell a public sector bank to an untested industrial house,” they said. 

“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,” they added. “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.”


Also Read: India’s banking rules need to close the door to tycoon cronyism


 

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5 COMMENTS

  1. Corporates already have collected money from public in name of shares and debentures. Banking will not be anything other than an extension of these thereby avoiding bank as middleman.

  2. Very well said Raghuram Rajan and Viral Acharya. It seems rather perplexing that why the RBI considers it necessary to expand the existing banking structure by handing over banking licenses to big industrial houses. Where is the need and who had demanded it? Instead of finding ways to improve quality of the existing banking structure, RBI wants quantitative growth in number of lending institutions, why? Two unrelated news can help us to solve this riddle. The first news says that commercial banks have outpaced middle sized NBFCs in home financing. The implications are clear. Despite the easy liquidity and the government prodding, the PSU banks are not willing to finance risky big ticket projects. Even the RBI Governor Mr. Das has said that banks should not be forced to finance large sized infrastructure projects. The government owned banks which were content in the past to lend to big corporates are now repenting due to accumulation of large NPAs and consequent losses. They have now chosen an easy way out : Lend to the less risky retail sector.

    The second news says that the government is contemplating an important amendment to IBR Act, relating to insolvency and bankruptcy of the corporate sector. This is regarding the prepackaged scheme for insolvency which involves giving legal sanction to plan agreed between banks promoters and buyers. Again, this is a as risky as giving away banking licenses to corporates. In its six years rule, the current dispensation has a solitary success in the field of economics and that relates to introduction and implementation of Insolvency and Bankruptcy Code. Once a company is admitted to the NCLT court, the board of directors and promoters lose all powers of managing and owning the company and these are transferred to lenders who will appoint resolution professionals to auction the company. Furthermore, promoters are not allowed to participate in the auction process. This is a pathbreaking reform and the NDA government must be complemented for having introduced such a bold reform. The results are for us to see. Big houses from Ruias, Anil Ambanis to the Singal family owning Bhushan Steel have been impacted. It is one thing to incur losses which even erode the entire capital, but the last thing that the promoters fear is losing their seat of owning these assets, Now, to involve these defaulting promoters in the resolution process is an atrocious idea. This shows how the corporate sector is unnerved by the introduction of IBR process. Hence the proposal to hand over licenses to the corporate sector so that borrowers can become lenders with the help garnering public deposits. This is a ruinous concept.

    Another justification produced for inducting big corporates in the banking sector is that this will lead to more competition and thus cause reduction in the cost of providing banking services. The moot point, however, is that this us not likely to happen. Introduction of private sector banks in the 1990s have facilitated use of technology in banking. This is a positive development. But this also helped these banks to introduce new kind of service charges, a novel way of improving profitability. Having a banking account has become more costly. Induction of big corporates in the field of banking is likely to aggravate this trend.

    A prudent way of avoiding this imbroglio is to strengthen and improve the existing public sector banking. Notwithstanding all that is said and written against the PSU Banks, people still have trust in these banks. The idea of inviting big corporates in the banking sector deserves to be discarded forthwith.

  3. Shouldn’t depositors decide where they park their money? I understand the obvious conflicts of interest that may arise but there are some inherent advantages with Corporates running banks esp the professionalism that they can provide. Also, many of the conflicts of interests can be mitigated with simple oversight and restricting stake and board positions. Nonetheless, more banks are good for a capital-starved nation like India.

  4. I m not agreed with them, bank is different form others company of the bankers, so as an example like Tata and Birla is more reliable then other small bankers…,

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