Permitting industrial houses to own banks

Context: Permitting industrial houses to own banks could undermine economic growth and democracy.

Background

• Recently, an internal working group of the RBI has made a far-reaching recommendation to permit industrial houses to own and control banks.
• According to the report, the reason for permitting industrial houses to own and control banks is that industry-owned banks would increase the supply of credit, which is low and growing slowly.
• However, many believe that this step would be a grievous mistake, and it will be a setback to Indian economic and political development.

Why it is a concern?

• Against the recommendations of the experts: The report states that majority of the experts were of the opinion that large corporate/industrial houses should not be allowed to promote a bank.
• The problem of connected lending: This can lead to Over-financing of risky activities, encouraging inefficiency by delaying or prolonging exit and entrenching dominance.
• Regulation of Connected lending is difficult: It is clear from the experience of Indonesia and most advanced countries that regulating connected lending is impossible and the only solution is to ban corporate-owned banks.
• Overburdened RBI: RBI has encountered much difficulty in dealing with banking irregularities at Punjab National Bank, Yes Bank, ILFS and Lakshmi Vilas Bank. Regulation and supervision need to be strengthened considerably to deal with the current problems in the banking system before they are burdened with new regulatory tasks.
• Can delay exiting of inefficient firms: This makes it impossible for more efficient firms to grow and replace them. If industrial houses get direct access to financial resources, their capacity to delay or prevent exit altogether will only increase.
• Can stimulate growth of Monopolies: Already, The Indian economy already suffers from over-concentration. The COVID-19 crisis is aggravating this picture because those with greater resources will not only more easily survive the crisis and they will be able to take over small, medium and large enterprises that have not had the resilience or resources. In this scenario, if large industrial houses get banking licences, they will become even more powerful.
• Will dampen rules-based well-regulated market economy: The power acquired by getting banking licences will not just make them stronger than commercial rivals, but even relative to the regulators and government itself. This will aggravate imbalances leading to a vicious cycle of dominance.
• Affect credit Quality: Indian financial sector reforms have aimed at improving both the quantity and the quality of credit. If India now starts granting banking licences to powerful, politically connected industrial houses, allowing them to determine how credit is allocated, it will effectively abandon the principle of ensuring that credit flows to the most economically efficient users.
• Alternative options do exist: The other powerful way to promote more good quality credit is to undertake serious reforms of the public sector banks.

Mixing industry and finance will set us on a road full of dangers for growth, public finances, and the future of the country itself.

The trend of Undermining the Role of Upper House