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RBI should let business houses set up and run banks in India

Financial stability risks would be outweighed by the likely gains of revitalizing our banking sector

In recent weeks, the Reserve Bank of India (RBI) has been in the news for several reasons. A former governor and deputy governor released their books blaming the government, for the most part, for the problems that India’s financial sector faces. They absolved the institution they served of any responsibility in the matter. Then, RBI’s monetary policy committee (MPC) kept interest rates unchanged after a meeting that was probably the current panel’s last, as its four-year term draws to an end. Hence, there were analyses of the trajectory of inflation in India over the past four years, with the implicit suggestion that correlation between RBI’s inflation- targeting regime and inflation performance is causation. The central bank announced a one-time debt restructuring. It also enhanced the loan-to-value ratio of gold loans to 90% after the price of gold reached a historic high. Finally and importantly, RBI appears to have shut the doors on India’s corporate houses wanting to set up banks, pointing to governance challenges.

If newspaper reports are to be believed, RBI wanted the right to scrutinize the financials of corporate sponsors on an ongoing basis. This has effectively shut the door on the possibility of large corporations setting up banks. This is an overkill. In 1969, when banks were nationalized, private sector banks had a poor track record on governance and credit disbursement. Those banks had largely served as financing vehicles for the industrial houses that promoted them. Further, the recent experience of Punjab and Maharashtra Cooperative Bank having diverted a huge proportion of credit to a favoured borrower is fresh in people’s minds. Yes Bank had to be rescued. These failures could be attributed to the limited capital and limitless ambition of founders. That said, it is inconceivable that reputed houses like the Tatas, Birlas, Reliance, Mahindra, Bajaj and Murugappa, to name some, would risk their reputation, considering the huge size of their other investments.

It is no secret that policy decisions invariably involve trade-offs. Credit diffusion in India remains weak. We are not advocating that it should rise to the levels seen in certain advanced countries or in China, for that could create other problems for the economy. Suffice to say that India has a low ratio of credit to gross domestic product. Two, frauds in government-owned banks have been rising much faster than their assets (see table 3.5 of RBI’s Financial Stability Report, December 2019) and profits. In any case, public sector banks had negative returns on equity and assets in 2017-18 and 2018-19. In fact, one of the reasons for the failure of demonetization to unearth unaccounted wealth was the nexus between banks and clients. This problem was concentrated in public sector banks.

Today, the norms on related party transactions are clear and RBI has tools to monitor and prevent this from becoming a menace. The central bank has already prescribed stiff minimum capital requirements for new banks to be licensed. It has also set governance standards for such institutions and for the probity of their managements. Further, as bank regulator, it has the right to tighten conditions for the grant of a licence. Finally, the licensing authority can reject applications.

Encouraging private capital to enter the banking sector is also an indirect way of reducing the share of government-owned banks in the system, and along with it, reducing the scope for them to run up bad assets every few years, resulting in the diversion of tax-payer money towards recapitalization and away from the development needs of the economy. More importantly, a capital-intensive industry needs players who can invest large amounts of capital. Government finances are not meant to provide capital for commercial enterprises. It only encourages political and executive interference in commercial decision-making, giving rise to conflicts of interest that central bank regulations can do little about, whereas inviting private capital addresses the problem.

This is what has happened in other sectors like steel, telecom and aviation. The private sector was allowed to grow and compete with the public sector. Consumers have benefited, huge investments have come in, prices have come down, and conflicts of government ownership have been eliminated substantially. The country may be missing a big opportunity by not letting some of its well-performing business groups set up banks.

In a recent interview, former RBI deputy governor Viral Acharya said that corporate houses routinely delayed payments to banks. The system has no in-built incentives nor disincentives for orderly debtor behaviour. He called for public disclosure of even a day’s delay in payments to banks for publicly listed companies, as is done in the case of bonds and marketable debt. It may not be too far-fetched to suggest that industrial houses getting a taste of their own medicine would over time lead to better repayment habits among businesses.

We agree that the financial sector cannot be a “free for all" zone of activity. Regulatory policies should facilitate the growth of the sector and ensure its stability. But, developing economies that focus exclusively on either of the two goals will enjoy neither.

V. Anantha Nageswaran and T.V. Mohandas Pai are, respectively, member of the Economic Advisory Council to the Prime Minister and chairman, Aarin Capital Partners. These are the authors’ personal views

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