Mumbai: The governor of the Reserve Bank of India, or RBI, on Tuesday expressed concerns over “gaps” in the existing regulations that could lead to corporations “self-dealing” in banks they promote or using them “as a private pool of readily available funds”.
The comments are significant because they come just days ahead of the scheduled release by RBI of the draft proposal on the entry of a new set of private banks into India’s Rs 64 trillion banking industry.
The Indian central bank is also in discussions with the government to split the posts of the chairman and managing director in state-run banks, the governor added, noting that the experience of a similar split in the private sector has been satisfactory.
Also Read | Allow farm loans at market rates: RBI
RBI wants changes in “statutes and regulations” to prevent private groups from misusing ownership of new banks, governor D Subbarao said at a banking conference organized by industry lobbies, the Federation of Indian Chambers of Commerce and Industry and Indian Banks’ Association.
Under existing banking laws, banks are not allowed to lend to directors on the board and entities in which they are interested. They also prohibit lending to relatives of directors without the prior approval of the board. Directors, who are directly or indirectly interested in any loan proposal, are required to disclose such interest and to refrain from participating in the discussion on the proposal.
Subbarao said it is difficult to prevent or detect “self-dealing” because banks can hide related party lending behind complex company structures or by lending to suppliers of the promoters and their group companies.
“There are, of course, both statutory and regulatory checks against self-dealing...As much as these prescriptions are extensive, there are still gaps,” Subbarao added. “For instance, if a company has an interest in a bank as a promoter or a shareholder, but has no position on the board, then there is no prohibition on the bank lending to the corporate. This opens up opportunities for self-dealing.”
Subbarao said that RBI has sent a draft amendment of the Banking Regulation Act to the government and that the government is working on the amendment.
“Amendments to the Banking Regulations Act are necessary before we contemplate corporations coming into banks,” he added on the sidelines of the seminar.
In March, the government tabled the Banking Laws (Amendment) Bill 2011 in the Lok Sabha proposing to give RBI more teeth.
The Bill proposes to give RBI powers to set conditions while approving the acquisition of share capital and also to call for information and returns from associate companies of banks that are engaged in financial services.
Finance minister Pranab Mukherjee in his February 2010 budget announced that the Indian central bank was considering giving licences to more private entities to set up banks. Following this, in August 2010, RBI released a discussion paper on relevant issues including capital requirement, the profile of promoters and foreign investment.
RBI sent its proposal to the finance ministry in January this year but the process got delayed due to the differences between the government and regulator on certain issues such as foreign direct holding. While RBI favoured a lower cap of 49% in the initial few years, the government was in favour of a higher 74% cap to attract more foreign funds to domestic market.
Among the contenders for a banking licence are Srei Infrastructure Finance Ltd, Religare Enterprises Ltd, Shriram Transport Finance Co. Ltd, L&T Finance Ltd, Bajaj Finserv Ltd, Indiabulls Financial Services Ltd, Birla Capital and Financial Services Ltd, Tata Capital Ltd and Reliance Capital Ltd.
After allowing nine new banks to set up shop and converting a cooperative bank into a commercial bank in the mid-1990s, RBI allowed two more private entities to float banks only in 2004.
Analysts said the regulator has to be cautious.
“For the system as a whole, provided there are enough safeguards in place, private parties can add value to the country. But the regulator has to be extremely cautious in selecting the new banks. Otherwise, the risks can have negative implications,” Vaibhav Agrawal, vice-president, research at Angel Broking Ltd, said.
Subbarao noted that there have been corporate governance issues among Indian banks. “We had instances of poor governance in the banking sector as well—erosion of standards in forex derivative transactions and fraud in wealth management schemes—reminding us that we need to work hard to get to best practice in every area of corporate governance.”
In April, the central bank penalized 19 banks, including the country’s largest lender State Bank of India, for violating rules on sale of derivatives. Later in July, it imposed a Rs 25 lakh fine on Citibank for violating norms in relation to a fraud committed by one of its staffers at its Gurgaon branch.
Subbarao said the boards and senior managements of banks have to be sensitive to the interests of the depositors and careful of the “potentially destructive consequences of excessive risk taking, be alert to warning signals and be wise enough to contain irrational exuberance”.
“The short point is this: If the directors on the boards of banks didn’t know what was going on, they should ask themselves if they were fit enough to be directors. If they did know and didn’t stop it, they were complicit in the recklessness and fraud,” Subbarao said.
RBI is in the process of finalizing the guidelines of compensation of whole time directors and chief executive officers in banks and this is expected to be implemented in the financial year 2012-13. Banks have already been advised to start preparatory work in this regard, Subbarao said.