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A Reserve Bank of India (RBI) panel recommendation to allow large industrial houses into banking has come in for criticism, with experts including former governor Raghuram Rajan warning against such a move.

“Why now? 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," said a LinkedIn post by Rajan and former RBI deputy governor Viral Acharya.

They said that since industrial houses need financing, they can get it easily, with no questions asked, if they have an in-house bank. The history of such connected lending is invariably disastrous, they said, wondering how a bank can 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. Information on loan performance is rarely timely or accurate. Yes Bank managed to conceal its weak exposures for considerable periods," the post pointed out.

The former top Reserve Bank of India (RBI) officials said another reason to prohibit corporate entry into banking is that it will worsen the concentration of economic (and political) power in certain business houses. Even if banking licenses are allotted fairly, they said, 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 tor licenses. That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism," said Rajan and Acharya.

They argued that while the regulator can choose between “fit and proper" businesses and shady ones, it has to be truly independent, with a thoroughly apolitical board.

“Whether these conditions will always pertain is debatable. Moreover, once the bank licence is given, the licensee’s temptation will be to misuse it because of self-lending opportunities," they said, adding that India has seen a number of promoters who passed a fit and proper test at the time of licensing turn rogue.

The bailout costs to the exchequer could be significantly more when it comes to bank licences to industrial houses, which will start out big, the post said. “Why is there urgency to change the regulation? After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to? Interestingly, the internal working group (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 said that the internal working group has suggested significant amendments to the Banking Regulation Act of 1949, aimed at increasing the RBI’s powers, before allowing corporate houses into banking. However, if sound regulation and supervision were only a matter of legislation, India would not have had a bad loan problem, they said.

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