Will the Corporate & Industrial houses run banks?

The Indian banking sector has been going through a very tough time since the past couple of years as we have seen a lot of big financial firms fail in the period of past 2 years. The issue of NPA has been troubling the government for a very long time. In order to foster growth and competition in the banking sector, an Internal Working Group formed by RBI has given a recommendation of allowing large corporate houses into full-fledged banking activities on 20th November. The Internal Working Group was formed by RBI to review extant ownership guidelines, licensing and corporate structure of Indian Private Sector Banks.

Here are some of the recommendations given by IWG

1. Entry of Corporate Houses into banking sector.

2. Conversion of NBFCs into Banks.

3. Conversion of Payments Banks into Small Finance Banks.

However, entry of these giants into banking will only be possible after doing necessary amendment to the Banking Regulations Act of 1949 to avoid connected lending.

According to IWG’s recommendation, any business houses with assets of more than 5000 Crores Rs. Where non-financial business of this firm accounts for more than 40% of the total assets will be allowed to set up banks.

As far as the conversion of NBFCs into commercial banks goes, the requirements for that are given as – The NBFCs who have been operational for more than 10 years with an asset of more than 50,000 Crores Rs. will be converted into Commercial Banks.

The idea of allowing these corporate houses to run banks is not new. In fact, prior to the financial crisis of the 1950's & 1960’s there were banks which were run by the Private Entities, which led to the nationalization of banks. The main reason behind nationalizing the banks was connected lending and the loans were often given without performing due diligence. As the business who operates the bank itself can take money out of one pocket and put it in another pocket in the time of need. This money is not from their own business but the money of depositors. So, in order to get rid of this connected lending necessary amendments have to be made into the Banking Regulations Act of 1949.

Looking from the economic point of view, this move may help boost the service sector of the country which will be a major contribution at achieving the target of a 5 Trillion $ economy which was proposed by our Honorable Prime Minister. But on the contrary Industries and Business are the biggest clients of Banks, Risks of them having their own banks are many such as inter-connected lending, Defaulting bank loans etc. NPA is a very big issue for a developing economy as we have seen many banks fail in the recent time due to the burden of the defaulted loans.

In fact, the former RBI governor Raghuram Rajan & Ex Deputy Governor Viral Acharya has strongly opposed this move. They said that “The history of connected lending is invariably disastrous; how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending.” Which is actually true. Also, it asks for the question, Why now? Why to bring it up now when the banking sector is going through a really tough time, struggling with the NPA’s.

Also, for banks to be successful, depositors and shareholders should be assured that their money is safe. Recent failure & Rescue of YES BANK & LAKSHMI VILAS BANK has proven otherwise.

Only Time will tell as if this recommendation is implanted, if yes what will be the effect it will have on the depositors, shareholders & economy as whole.

Thank you.

Regards,

Raj Gudhka,

Kautilya,

IBS Mumbai.