Pros and cons of banking licences for big businesses

An internal working group of the RBI has suggested that large corporates and industrial houses may be allowed to promote banks. Does this leap of faith make sense, given our central bank’s extremely cautious and conservative approach? Mint takes a look

Vivek Kaul
Updated22 Nov 2020
Photo: Mint
Photo: Mint

An internal working group of the Reserve Bank of India has suggested that large corporates and industrial houses may be allowed to promote banks. Does this leap of faith make sense, given our central bank’s extremely cautious and conservative approach? Mint takes a look.

Why should large cos be allowed in banking?

RBI’s working group feels that allowing corporates to promote banks can be an important source of capital. In a capital-starved economy like India, this makes sense. Further, these corporates can bring “management expertise, experience, and strategic direction to banking”. The group also noted that internationally, “there are very few jurisdictions which explicitly disallow large corporate houses”. All these reasons make sense, but there are major drivers behind RBI not allowing corporate intrusion in the banking sector over the last five decades. At the heart of this is the conflict of interest it would create.

Why have corporates been kept away so far?

The RBI panel spoke to experts on the issue: “All the experts except one [said] that large industrial houses should not be allowed to promote a bank.” The corporate governance in Indian companies isn’t up to international standards and “it will be difficult to ring-fence the non-financial activities of the promoters,” the experts said. There will also be a risk of promoters giving loans to selves. Before the bank nationalization happened in 1969, some of the private banks were owned by large corporates. Prof. Amol Agrawal of Ahmedabad University points out that back then, big industrialists used to give loans to themselves.

Key defaulter

What does the history of banking system reveal?

V.A. Pai Panandiker, an advisor in finance ministry, wrote in August 1967: “Internal procedures… vest large discretionary powers in the boards of directors who have often acted as sources of patronage in deciding credit matters.” A survey also showed that 188 individuals served as directors on boards of 20 leading banks and held 1,452 directorships of other firms.

What did corp’s huge power lead to in 1966?

An October 1967 report commissioned by politician Chandrashekhar, the then secretary of the Congress Party found that of the total bank loans amounting to 2,432 crore in 1966, 292 crore was given to bank directors and their companies.

In fact, if indirect loans and advances were included, the actual amount owed by directors was 600-700 crore. With corporates in the scene, there is a danger of something similar happening much more now, given the weak corporate governance structures.

What does this mean in current scenario?

In March 2018, the domestic bad loans of Indian banks peaked at 9.62 trillion. Of this, around 73.2% or 7.04 trillion, were defaults made by the industry. Corporates have thus been responsible for a bulk of the mess in the Indian banking sector. In such a precarious circumstance, it’s apparent that the banking regulator will have to tread with a great deal of caution and oversight to execute this plan.

Vivek Kaul is the author of Bad Money.

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