Corporates as banks - Concerns

Why in news?

An Internal Working Group (IWG) of the RBI constituted to “review extant ownership guidelines and corporate structure for Indian private sector banks” recently submitted its report.
Among the recommendations, a key and controversial one is to do with allowing large corporate/industrial houses to be promoters of private banks.

Had there been similar recommendations before?

In February 2013, the RBI had issued guidelines that permitted corporate and industrial houses to apply for a banking licence.
Some houses applied, although a few withdrew their applications subsequently.
No corporate was ultimately given a bank licence.
Only two entities qualified for a licence, IDFC and Bandhan Financial Services.
The RBI maintained that it was open to letting in corporates. However, none of the applicants had met ‘fit and proper’ criteria.
RBI had also emphasized on the public concern about bank governance at that time.

In 2014, the RBI restored the long-standing prohibition on the entry of corporate houses into banking.
The RBI Governor then was Raghuram G. Rajan who had headed the Committee on Financial Sector Reforms (2008).
The Committee had been against the entry of corporate houses into banking.
- It felt back then that it would be premature to allow industrial houses to own banks.
- This prohibition on the ‘banking and commerce’ combine still exists in the United States today.
- The same is certainly necessary in India till private governance and regulatory capacity improve.
The RBI’s position on the subject has remained unchanged since 2014.

What is the rationale now?

The Indian economy, especially the private sector, needs money (credit) to grow.
The government-owned banks are far from being able to extend this credit.
Even more, the government-owned banks are struggling to contain their own non-performing assets.
Government finances were already strained before the COVID crisis.
With growth faltering, revenues have fallen and the government has limited ability to push for growth through the public sector banks.
Given all these, large corporates are the ones with the financial resources to fund India’s future growth.
Corporate houses can bring capital and expertise to banking.
Moreover, not many jurisdictions worldwide bar corporate houses from banking.

What are the concerns with 'corporate-owned banks'?

Concentration of economic power - Corporate houses can easily turn banks into a source of funds for their own businesses.
In addition, they can ensure that funds are directed to their cronies, provide finance to customers and suppliers of their businesses.
Even in private bank ownership, past regulators have preferred it to be well diversified i.e. no single owner has too much stake.
Risks - RBI has always been of the view that the ideal ownership status of banks should promote a balance between efficiency, equity and financial stability.
- A greater play of private banks comes with its own risk element. The global financial crisis of 2008 is a case in point.
- On the other hand, a predominantly government-owned banking system tends to be more financially stable given the trust in government as an institution.
Moreover, banks owned by corporate houses will be exposed to the risks of the non-bank entities of the group.
- If the non-bank entities get into trouble, sentiment about the bank owned by the corporate house is bound to get affected.
- In that case, depositors may have to be rescued through the use of the public safety net.
Connected lending - The main concern in allowing large corporates to open their own banks is a basic conflict of interest, or more technically, “connected lending”.

In simple terms, connected lending refers to a situation where the promoter of a bank is also a borrower.
In other words, it is possible for a promoter to channel the depositors’ money into their own ventures.

Why is connected lending a big challenge?

Connected lending has been happening for a long time and the RBI has been falling short in having a check on it.
The recent episodes in ICICI Bank, Yes Bank, DHFL etc. were all examples of connected lending.
The so-called ever-greening of loans is often the starting point of such lending, wherein one loan after another is extended to enable the borrower to pay back the previous one.
Regulation - The IWG has called for a legal framework to deal with interconnected lending.
It also recommended having a mechanism in place to effectively supervise conglomerates that venture into banking.
However, any legal framework and supervisory mechanism will be less adequate to deal with the risks of interconnected lending in the Indian context.
- Corporate houses are proficient at routing funds through a network of entities in India and abroad.
- So, tracing interconnected lending will be a challenge.
- Also, monitoring of transactions of corporate houses will require the cooperation of various law enforcement agencies.
Ex-post - The RBI can only react to interconnected lending ex-post i.e. after substantial exposure to the entities of the corporate house has happened.
Given this, it is less likely to be able to prevent such exposure.
Even after spotting, it is challenging to make course corrections.
This is because any action that the RBI may take in response could cause a flight of deposits from the bank concerned and precipitate its failure.

Public sector banks - Beyond the idea of growing a bank on their own, the real attraction for corporate houses will be the possibility of acquiring public sector banks (PSBs).
Notably, the valuations of PSBs have been weakening in recent years.
Public sector banks now need capital that the government is unable to provide.
So, the entry of corporate houses, if it happens at all, is likely to be a prelude to privatisation.

In that case, any sale of public sector banks to corporate houses would raise serious concerns about financial stability.

How about NBFCs conversion into banks?

The IWG argues that corporate-owned NBFCs have been regulated for a while and thus the RBI understands them well.
However, there is much difference between a corporate house owning an NBFC and one owning a bank.
Bank ownership provides access to a public safety net whereas NBFC ownership does not.
The reach and influence that bank ownership provides are vastly superior to that of an NBFC.
In all, it is advisable in the present context to keep the class of borrowers (big companies) apart from the class of lenders (banks).

Source: The Indian Express, The Hindu