Amending existing laws to check connected lending by corporates in banking could present challenges
Going by precedence, it is likely that a few regime-friendly corporate groups will launch banks, after which the doors will be shut again, allowing them to consolidate their presence
The Indian financial services sector has been convulsed after an internal working group of the Reserve Bank of India (RBI) recommended last week that large companies be allowed to own commercial banks. In the midst of rising uncertainties, especially with pandemic-related insecurities tightening its grip on the world, this bit of alarming certitude has worked up a lather in the finance industry. Former governors, commentators and policy experts have responded at the speed of digital payments, most of them roundly criticising the proposal.
But everybody seems to have treated the group’s promise of building safeguards perfunctorily; this is a lethal landmine, the real danger to India’s feeble and unsteady policy environment, given the Indian corporate sector’s unimpeded ability to shape and reshape it.
The internal working group (IWG) was set up by RBI governor Shaktikanta Das on June 12 to “review the extant guidelines on ownership, governance and corporate structure in private sector banks, taking into account key developments over the years which have a bearing on the issue".
The IWG was chaired by RBI’s central board director P.K. Mohanty (a former Indian government secretary) and included another board member (Sachin Chaturvedi, director-general of government-owned, Delhi-based think tank, RIS) and three RBI employees (executive directors Lily Vadera and S.C. Murmu; and chief general manager S. Yadav).
Surprisingly, IWG has recommended corporate ownership of commercial banks even when almost all external experts–barring one–have advised against the move. IWG invited four former RBI deputy governors, two bankers, one lawyer, one consultant and a private equity player for expert advice.
IWG’s decision to go ahead with its recommendation, despite advice to the contrary, indicates that either it had access to data that overwhelmingly suggests otherwise, or its perceived need for corporate-owned banks is so acute that it justifies disregarding all opposition. Alternatively, there were some other compulsions which don’t exist in the public domain.
Whatever be the case, the recommendation has drawn flak. The IWG’s defence is that it has also recommended remedial measures to check any possible misuse of its bank shareholding: it has suggested that the Banking Regulation Act be amended to check connected lending.
Former RBI governor Raghuram Rajan and former RBI deputy governor Viral Acharya counter this: “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…if sound regulation and supervision were only a matter of legislation, India would not have an NPA problem."
The former RBI governors are not wrong, but their argument could actually be distorted to support what they are contesting: Only legal teeth can strengthen the current regulatory and supervision frameworks. This is the keyhole, the needle’s eye, through which the first lot of corporate entries could be squeezed in.
In fact, the IWG’s caveats on amending extant legislation have dangerous post-policy implications.
The slippery slope
The first is the slippery-slope analogy: Once you start going down that gradient, it becomes difficult to control the descent. It has been the experience in India that once a small relaxation is allowed, it affords powerful lobbies space to keep driving wedges that finally change the original complexion of the regulation or legislation.
The telecom regulatory landscape offers numerous examples of policy flip-flops–across ministers and governments–that fittingly demonstrate how policy structure is inherently unstable and malleable to external influences. The 1999 New Telecom Policy was the first sign of a government mounted rescue for the private sector when all telcos were migrated to revenue sharing from fixed revenue payments.
Nobody stopped to ask why telcos had made such bold licence bids which miscalculated market potential by miles. The policy instability has continued; in the decades since the sector was first opened up to private investment, across governments of all political hues, policy choices have ended up creating an oligopoly instead of free competition and improved consumer choice. The Indian telecom sector now resembles a graveyard for international brands.
Here is another example: In September 2017, a minister threatened auto-makers with dire consequences if they did not shift immediately to electric vehicles, without bothering to thrash out the mechanics of the shift or discuss the roadmap with industry. This policy was abruptly over-turned five months later, in February 2018. Meanwhile, progress has been slow on the National Electric Mobility Mission Plan.
Many other areas have been subject to policy flip-flops: foreign direct investment in e-commerce, aviation (especially privatisation of airports), media and entertainment, renewable energy…the list goes on. In many sectors, sharp and unpredictable policy turns were clearly designed to help one company or a particular group of companies. It starts with one small innocuous change which looks like reforms, and is sold like reforms, but is actually a bespoke alteration. This then becomes the first step in a series of multiple custom-built changes.
RBI’s strong institutional presence has been able to only partially insulate the banking industry. For one, because the government is the dominant shareholder in some of the largest banks and also because the government has a legally-sanctioned hierarchical advantage to occasionally ram through policy shifts.
Some examples: the first lot of private banking licences surprisingly included one corporate; the finance ministry forced RBI to approve a particular merger in the private banking space despite the central bank’s misgivings; finance ministers forcefully appointing under-qualified bankers as deputy governors to further government agenda.
Currently, various regulatory measures enacted to check bad banking and bad loans have now been reversed, mostly in the fond belief that easy credit is the fastest road to higher economic growth. The Rajan-Acharya note raises a related concern: “The RBI recognized the risk of excessive exposures to specific houses in 2016 by announcing group exposure norms, which limit how much exposure the banking system can have to specific industrial houses. These norms have been relaxed recently."
Former RBI governor Urjit Patel’s recently released book Overdraft: Saving the Indian Saver outlines how the central bank’s stringent regulatory measures to check burgeoning bad loans–attributable largely to the big and medium sector companies–were relaxed after a reshuffle of governors. The Insolvency and Bankruptcy Code has been suitably diluted, allowing corporate loan defaulters greater latitude. The government has now inserted itself in the equation between banks, RBI and loan defaulters.
Here then is the problem with allowing corporate groups to own banks, under the facile façade of amending existing laws: it will most likely allow powerful corporate lobbies to continuously chip away at the Act, with an acquiescent government and central bank aiding the process.
The first man in
The Indian policy ecosystem has another dubious credit to its account: On many occasions, entry norms were relaxed to facilitate the admission of only one or two participants. Once they got in, the doors were shut again.
The audit and accounting industry is a good example. The sectoral regulator, Institute of Chartered Accountants of India, is allergic to multinational audit firms, fearing that they will take away business from domestic firms. But despite this unfounded misgiving, the regulator allowed the infamous Arthur Andersen to legally do business in India, while disallowing many other big names.
In banking, RBI has provided universal banking licences to only four NBFCs so far: HDFC Ltd, 20th Century Finance (Centurion Bank, which was acquired by HDFC Bank), Kotak Mahindra Finance and IDFC Ltd. There is a fourth entity–Bandhan Bank–if you consider microfinance an NBFC of sorts. But, it has shut the doors thereafter.
Going by precedence, it is not entirely improbable that the door will be left ajar just a bit to allow a few, regime-friendly, corporate groups to launch banks, after which the doors will be shut again, allowing them to consolidate their presence across key sectors.
The credit canard
The drum-beat for allowing corporates to own banks has been growing steadily. The oft-cited excuse is more banks are needed to grow credit volumes, and thereby India’s growth potential.
In a piece in this paper, former ICICI Bank CEO K.V. Kamath suggested that corporate banks might be necessary to increase India’s economy. In September, RBI central board member Manish Sabharwal told the All India Management Association that more banks are needed to take credit-to-GDP ratio to 100%. To be fair, he did not specifically mention corporate-owned banks, but then endorsed the view that more banks will automatically lead to more credit, and thereafter to higher economic growth. Available evidence does not support this contention.
The banking structure till September 2013 consisted mainly of public sector banks, old private banks, new private banks, foreign banks, regional rural banks and local area banks. This is not including the parallel, and multi-layered, structure of cooperative banks.
Then along came RBI governor Raghuram Rajan and he created three additional categories of banks during his tenure: universal, small finance banks (SFBs) and payment banks. He also wanted to create custodian banks and wholesale (or long-term financing) banks but had to leave before fully realising his vision. Under his watch, licences were issued for two universal banks, 10 SFBs and 7 payments banks.
And yet, the needle has barely moved on India’s credit-to-GDP ratio. According to the Bank for International Settlements, India’s credit-to-GDP ratio has been languishing below the long-term trend since 2015. A government appointed committee’s 2008 report on improving financial inclusion, headed by former RBI governor C Rangarajan, had submitted that merely increasing the supply-side, or credit infrastructure, is meaningless without first improving demand conditions.
Here is another counterfactual: If a majority of foreign banks is reluctant to operate as wholly-owned subsidiaries, because that requires opening 25 rural branches, will corporate-owned banks do business away from over-banked and crowded urban centres and help improve the credit-to-GDP ratio?
Rajan had also faced pressure to allow corporates into commercial banking. He complied but only partially: He allowed corporates (mostly those with telecom licences) to operate as payments banks, where the regulatory business model frowned upon profit generation.
But, more importantly, while small finance banks could graduate to universal banks, subject to certain regulatory conditions, payments banks had no escape route. Once a payments bank, always a payments bank. Understandably then, of the 11 in-principle approvals granted, only seven took their licences, of which one surrendered its licence recently.
It should, therefore, come as no surprise that IWG has now recommended that payments banks with only three years of experience can convert to SFBs, improving upon the RBI’s December 2019 time-limit of five years. All of them are now eligible; but if the IWG proposal for corporate-owned universal banks is accepted, at least one payment bank is likely to surrender its licence and leapfrog straight to a universal bank.
This is where the rubber hits the road. This sudden desire for corporate-owned commercial banks is not born in a vacuum. Policy formulation in India is usually designed to benefit a corporate client or a group of corporate clients; citizens and customers are lowest on the totem pole. Political science has a word for this: plutocracy.
Rajrishi Singhal is a policy consultant, journalist and author.
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