corporate houses in Indian banking

Context: Recently, an Internal Working Group of the Reserve Bank of India (RBI) has recommended that corporate houses be given bank licences.

Background

• Earlier, in 2013, the RBI had issued similar guidelines permitting corporate and industrial houses to apply for a banking licence. However, no corporate was given a bank licence as none of the applicants had met ‘fit and proper’ criteria.
• In 2014, the RBI, reversed its earlier decision and prohibited the entry of corporate houses into banking based upon the Committee on Financial Sector Reforms (2008) suggestion that opined it is premature to allow industrial houses to own banks.
• Now, an Internal Working Group of the Reserve Bank of India (RBI) has once again recommended for providing bank licences to corporate houses.

What are the Pros and Cons of letting corporate houses to operate banks?

Pros:

• Corporate houses will bring capital and expertise to banking.
• In many countries corporate houses were not bared from banking.

Cons

• Interconnected lending: They can use banks to provide finance to customers and suppliers of their businesses.
• Concentration of economic power.
• Exposure of the safety net provided to banks to commercial sectors of the economy.
• Fund diversification: by turning banks into a source of funds for their own businesses.
• Impact of Non entities on banks growth: Banks owned by corporate houses will be exposed to the risks of the non-bank entities of the group.
• Privatisation of Public banks in the long run: For example, Public sector banks need capital that the government is unable to provide. The entry of corporate houses will result in the possibility of cash rich corporate bank acquiring cash trapped public sector banks which is a serious concern about financial stability.

Why Tracing interconnected lending will be a challenge?

• The Internal Working Group suggests that, before corporate houses are allowed to enter banking, the RBI must be equipped with a legal framework to deal with interconnected lending and a mechanism to effectively supervise conglomerates that venture into banking.

However, there are challenges while dealing with interconnected lending.

• Multi sector cooperation required: Monitoring of transactions of corporate houses will require the cooperation of various law enforcement agencies.
• Crony capitalism: Corporate houses can use their political clout to thwart such cooperation.
• No prevention possible: The RBI can only react to interconnected lending ex-post; it will not be able to prevent such exposure.
• Complex process: In case, even if RBI could trace interconnected lending, any action taken on corporate will only cause a flight of deposits from the bank concerned and precipitate its failure.
• Regulator credibility at stake: The regulator would be under enormous pressure to compromise on regulation. Pitting the regulator against powerful corporate houses could end up damaging the regulator.

Why the Internal Working Group of the RBI has recommended so?

• Under the present policy, NBFCs with a successful track record of 10 years are allowed to convert themselves into banks.
• There are corporate houses that are already present in banking-related activities through ownership of Non-Banking Financial Companies (NBFCs).
• The Internal Working Group believes that NBFCs owned by corporate houses should be eligible for such conversion.
• The Internal Working Group argues that corporate-owned NBFCs have been regulated for a while. The RBI understands them well. Hence, some of the concerns regarding the entry of these corporates into banking may get mitigated.

India’s banking sector needs reform but corporate houses owning banks will not be the one that is required as of now.

Why Corporate houses should not own banks?