Raghuram Rajan says proposal to allow business houses into banking is a ’bad idea’

New Delhi: Raghuram Rajan and Viral Acharya on Monday criticised RBI Internal Working Group's recommendation to allow Indian corporate houses to set up banks as part of proposed changes to the banking sector.

Raghuram Rajan, a former RBI governor, and Viral Acharya, a former RBI deputy governor, said the proposal is a "bad idea".

"It will further exacerbate the concentration of economic (and political) power in certain business houses," they said about the IWG proposal in a note published on Monday on LinkedIn.

Rajan is currently Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago Booth School of Business and Acharya is a professor at the Stern School.

They questioned the timing of the propoal at at time when "India is still trying to learn the lessons from failures like IL&FS & Yes Bank".

"Many technical rationalisations proposed by RBI's Internal Working Group are worth adopting, while its main recommendation, to allow Indian corporate houses into banking, is best left on the shelf," argued Rajan .

"The history of... connected lending is invariably disastrous -- how can the bank make good loans when it is owned by the borrower? 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," they said.

Referring to the group's proposal to allow Indian corporate houses into banking, the article said, "its most important recommendation, couched amidst a number of largely technical regulatory rationalisations, is a bombshell".

"... it proposes to allow Indian corporate houses into banking. While the proposal is tempered with many caveats, it raises an important question: Why now?," the article said.

They also questioned the urgency to change regulation, especially given that committees are rarely set up out of the blue.

"Why is there urgency to change the regulation? After all, committee are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?" ask the former RBI officials.

"Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking," the article said.

"If sound regulation and supervision were only a matter of legislation, India would not have an NPA problem," they said.

The former RBI officials also said, "India has seen number of promoters who passed fit & proper test at the time of licensing but then turned rogue."

They noted that the rationales for not allowing industrial houses into banking are then primarily two. First, industrial houses need financing, and they can get it easily, with no questions asked, if they have an in-house bank.

According to Rajan and Acharya, the second reason to prohibit corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses.

"Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses," they said.

Interestingly, the IWG reports in its appendix that all the experts it consulted except one 'were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank'.

"Yet it recommends change!," they pointed out.

Rajan and Acharya have also expressed their views against reducing the conversion time for payment banks to convert into banks.

"A second possibility is that an industrial house holding a payment bank license wants to transform into a bank.

"One recommendation of the IWG that is equally hard to understand is to shorten the time for such transformation from five to three years, so perhaps the surprising recommendations have to be read together," they argued.

Last week, an RBI panel had proposed that large corporates may be permitted to promote banks, as well as raising the cap on promoters' stake in private sector banks to 26 per cent, from15 per cent at present.

The RBI panel has recommended that corporates should be allowed to control banks after necessary amendments to the Banking Regulation Act, 1949 to prevent connected lending and exposures between the banks and other financial and nonfinancial group entities.

The RBI proposes that only well-managed NBFCs with over 10 years of experience and ₹50,000 crore of assets will be allowed to convert to a bank.

S&P Global Ratings, on Monday, also expressed scepticism over allowing corporate ownership in banks given India's weak corporate governance amid large corporate defaults over the past few years.