Home / Opinion / Views /  Should our manufacturers be allowed to set up banks?

The Reserve Bank of India (RBI) working paper which recommends that manufacturing groups and business houses be allowed bank licences , while mapping global norms against this and disclosing that all but one of the experts consulted were against this, has generated plenty of heat. Like almost everything else right now in India, views on the issue largely depend on which side of the political spectrum you swing on policy matters. Considering the content, disclosures and manner of this idea’s presentation, it looks to me as if this is a kite flown to see what reactions emerge. The Narendra Modi government is unlikely to spend political capital on such a big change if there are enough signals that it would be a vote loser. But since the kite is in the sky, we should use the opportunity to think through the issue of letting manufacturers own banks while trying to keep politics out of it. I will outline three areas to look at this question from different windows.

But first, why do we need manufacturing groups in banking? Because India is capital starved and needs money to grow. Public sector banks (PSBs) have eroded their capital through a mix of poor lending decisions and politically-nudged free money to business cronies for the past many decades. The playbook of funding cronies with the public money of PSBs, then recapitalizing these banks using taxpayers’ money (and by borrowing), and then inflating away the debt, has destroyed the balance sheets and morale of PSBs. Private banks find retail lending more profitable and less risky than corporate lending. The flow of capital that India needs for its next stage of growth is missing. Therefore, the need for letting firms with the deep pockets required into the banking sector at this juncture. But this is a contentious issue, globally. So, how should we look at it?

Let’s examine it through three windows. One, was allowing private entities into banking, overturning Indira Gandhi’s socialist ideal of public money in PSBs to achieve the public good, a mistake back in 1993? No, because not only did PSBs not achieve that ideal, India remained a largely unbanked country with a very poor credit spread. The entry of private banks altered the trendline of banking in the country, with much better services, use of technology, efficiency, lending decisions and margins. The credit trendline shows a sharp upward movement post 1993 (see the chart on page 17 of the RBI report here.

We need to look at the current issue in the context of similar reactions each time there is a move towards privatization or a discussion on raising the investment limits for foreign investors in certain sectors. It is then that our risk-averse policy voices, intellectuals and other interested parties typically offer resistance.

Raising the caps on foreign holdings in insurance companies, for example, took years of negotiation by the government of the day with Left parties and worker unions. In another instance, the country’s National Pension System (NPS) was hobbled by the mandate to only use public-sector pension fund managers in its initial years. There is always going to be resistance from incumbents to an idea that would either alter or threaten the status quo and their interests.

Two, there are real concerns over the possible misuse of depositors’ money by manufacturers for their own or associated companies’ purposes. Global best practices frown upon such bank ownership, and there are also issues of the concentration of economic power in a few hands.

These are real concerns and must be thought through. But we must also acknowledge that the absence of corporate ownership has not prevented either bank failure or the misuse of depositors’ money in the past few decades. The year 2020 has already seen two banks nearly fail; they would have gone under without gunshot weddings arranged by RBI.

If indeed India’s banking sector needs the capital that only a few large business houses have, can policy and regulation not institute a set of rules that prevent the own-use and misuse of money? What if there is a clear bar on own-company or associated-company use of money by a bank’s promoter group?

Three, there seems rather little confidence in RBI’s competence as an efficient and effective bank supervisor and regulator. To ex-post arrange the merger of a failed bank with a healthy bank is a very different story than having the ability to sniff out, and act upon, smoke signals that a failing bank emits long before it finally collapses. In this piece, ‘More banks won’t solve problem of money supply’, I argue that RBI needs to use big data, artificial intelligence and a change in its regulatory playbook to become an effective regulator, and that we need an early warning system to ring alarm bells far earlier than today.

India is in a unique spot in its growth trajectory and geopolitical role in a world emerging out of the pandemic. We should use this moment to think through deep reforms within our banking regulations that would support a new cycle of banking activity and promote economic growth ahead. India needs capital to grow, and if we can place enough security walls around the misuse of money, we should consider every idea on the table without letting political ideologies get in the way.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation.

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