On corporatisation of banks: Companies Needn’t Own Banks

News: Recently, RBI’s Internal Working Group (IWG) on ownership guidelines of private sector banks recommended that large corporates and industrial houses be allowed to be promoters of banks.

However, recent trends suggest that the financial system can meet the growing demand for credit for the next three to five years, without taking on the risk of issuing licences to industrial houses.

Why it was proposed that large corporates and industrial houses be allowed to be promoters of banks?

Increased in demand for loans: Indian Economy needs new investments in the financial system to sustain its growth. If the economy has to grow in double digits every year in nominal terms (real growth plus inflation), demand for loans is likely to grow.

But the credit growth from PSBs has been poor compared to private banks. For instance, Private banks share of bank loans increased from 21% in 2010 to 36% in 2020, as the share of PSBs fell from 74% to 60%.

Considering, even if all current private banks grow at twice the nominal GDP growth and non-banks and bond markets show healthy growth, it will be difficult to meet economy’s future demand.

In this context, it was suggested that large corporates and industrial houses be allowed to be promoters of banks.

However, the potential capacity of India’s financial system has been boosted meaningfully in the last two years. This has forced a rethink.

What are the recent steps taken to boost India’s financial system?

Decision to privatise two PSBs: This can hopefully trigger better governance and performance in the remaining PSBs.

Setting up of the new development finance company with a lending target of Rs 5 trillion within three years (this is 3% of total outstanding private credit in FY21), will supplement financial capacity.

Surge in equity investments in technology-enabled financial firms (FinTech): Through better use of data and analytics, these firms identify lending opportunities, making the risk more manageable compared to risk-averse lenders like PSBs.

IWG’s suggestions helped to add equity capital in the system: For instance,

Increasing Promoters’ stake to 26%, higher than the 15% permitted earlier.

Non-promoter shareholding threshold being raised to 15% from 10% is a potential opportunity for getting more private equity investments into some of the smaller private banks.

Increasing bank base: Several existing licensed firms are also progressing from being payment banks to small finance banks, onward to becoming universal banks within few years.

Source: This post is based on the article “Companies Needn’t Own Banks” published in TOI on 10^th Dec 2021.