New Delhi: The International Monetary fund (IMF) has warned India against licensing corporate entities to step into the business of commercial banking, saying the risks associated with such a move potentially outweigh the benefits of creating more banks.
IMF’s Financial System Stability Assessment Update said it would be prudent for India to first put in place and gain sufficient experience in implementing a comprehensive framework for the purpose before considering the entry of conglomerates into banking.
“The legal, operational and regulatory framework for consolidated supervision of both bank-led groups and financial conglomerates is still missing some important elements,” it said, while also flagging concerns about the lack of total independence for the Reserve Bank of India (RBI) from government influence.
This warning precedes the expected release of the final set of bank licensing guidelines by RBI later this month, expected to kick-start the process of new private sector entities getting licences to open commercial banks.
Last month, Parliament passed the Banking Laws (Amendment) Bill, 2011, empowering the central bank to supersede bank boards and scrutinize associate companies of bank promoters. The passage of the Bill had been a key precondition set by RBI to start issuing new bank licences.
RBI had been reluctant to give banking licences to companies that could use the lender’s funds for the benefit of other group units and deny funds to rivals, and had sought the power to supersede boards of potential rogue banks.
International experience supports disallowing industrial houses from promoting and owning banks, IMF said.
“Consolidated supervision frameworks and capabilities are weak even for bank-led groups in the majority of jurisdictions assessed...and frameworks for the oversight of financial conglomerates continue to be a ‘work in progress’ at the international level,” it said.
A senior finance ministry official said sufficient safeguards would be put in place to ensure that the new banks don’t lend to group companies.
“The new banks will not be allowed to lend to group companies. Because of this, we have written to the Reserve Bank of India that even companies with exposure to real estate and stock broking could also be considered,” the official said on condition of anonymity.
The ministry expressed its views to RBI ahead of the regulator issuing final guidelines for new bank licences. The central bank, however, in the first round of granting licences may favour non-banking financial companies rather than large industrial conglomerates.
“There are serious areas of concern with family-controlled banks. The managerial team will have ‘high-powered incentives’ that come with high shareholding. Their super-incentivized staff will be energetic in dodging regulation; our financial regulatory agencies will not be able to rein them in,” said Ajay Shah, a professor at the National Institute of Public Finance and Policy.
“There is tension between the need for greater competition in banking and the entry of family-controlled banks. Luckily, there are two pathways through which we can avoid these complexities,” he said. “The first is to have entry by dispersed-shareholding banks, controlled by no family, and the second is to have entry by foreign banks.”
IMF’s concern also stems from the fact that several legal provisions, including those in the Banking Regulation Act, limit the independence of the central bank.
“Some legal provisions in the Banking Regulation Act allow the central government to give directions to RBI, require RBI to perform an inspection, overrule RBI’s decisions, and supersede the RBI central board,” the report pointed out. “Removing these provisions and specifying in law the reasons for removal of the head of the central bank during his/her term would provide greater legal certainty regarding RBI independence.”
On the question of autonomy of Indian regulators, RBI said financial sector regulators in India operate within statutory frameworks that “prudently balance the role of government in policymaking with autonomy and independence for regulatory bodies to transparently perform regulatory functions through exercise of statutory powers”.
“The de facto position, too, reveals no interference in the functioning of regulators. Steps are underway to accord a statutory basis to the pension regulator also,” RBI said in a statement on Wednesday.
The IMF report cited gaps in prudential regulation, including the large exposures and related-party lending regime in banks, and valuation and solvency requirements in insurance.
“The combination of a sharp credit expansion and a more recent economic slowdown is putting pressure on banks’ asset quality, especially for infrastructure and priority sector lending. Group concentrations have reached troubling levels at some banks,” IMF said.
The central bank, while agreeing that the group borrower limit in India was higher than international norms, said keeping the group borrower limit at the level of the single borrower limit would severely constrain the availability of bank finance. This would hamper the growth of the economy as major corporate groups are key drivers of growth, RBI said.
The current exposure limit is a maximum of 55% of a banking group’s capital against 10-25% followed internationally.
IMF, in its report, pointed out that although India’s oversight regime for banks, insurance and securities markets was largely in compliance with international standards, some gaps remain.
“A common issue across the sectors is the lack of de jure independence, which can be rendered more challenging by the intricate relationship with state-owned supervised entities and their business decisions. A framework for consolidated supervision of financial conglomerates is still being developed,” IMF said in its report.
RBI said the central bank had made efforts to establish information-sharing mechanisms with various jurisdictions in which Indian banks were operating. “With regard to the information sharing and coordination among domestic regulatory authorities, it may be noted that the FSDC, under the chairmanship of finance minister, provides for effective regulatory coordination,” it said.
FSDC is short for Financial Stability and Development Council, a panel of financial regulators headed by the finance minister.
IMF also expressed concern on the multiple roles of RBI, which may be conflicting. “RBI officers are nominated as directors on the boards of public banks, while at the same time RBI serves as the prudential supervisor of these banks. It would be preferable for the government to focus on policies that ensure the appointment of well-qualified, independent board members that are not from RBI,” the report said.
The central bank admitted that there could be “moral hazard” issues and said it had taken up the matter with the government for amendment of the enabling legal provisions.
IMF also pointed out that the government needs to look for ways to manage its ownership so that public banks can meet the needs of a growing economy.
“RBI should ensure that a conflict be avoided and policies decided in accordance with that. But most of the observations of IMF are exaggerated,” said Bimal Jalan, a former governor of RBI. “India is absolutely on the right track and a number of policies that we are following like a flexible, but managed exchange rate are being adopted by other countries.”