Allowing Corporates In Banking: Benefits & Challenges

Banking system in India constitutes the bedrock of Indian Financial System. Banks had started operating in the country in the 18th Century. Before Independence more than 500 banks were established in the country but only a few could survive.

The Colonial rulers established various banks, which were nationalized after the Independence to better serve the needs of development of the economy in conformity with national policy objectives. In the 1970s, RRBs were established to extend banking services to the Rural and agricultural regions. Specialised banks such as NABARD, SIDBI, HDFC, IDBI etc. also catered to the needs of different sectors of the economy.

• At present, private sector entities with a 10 year successful history in financial sector having 5000 crore of assets where 60% of the assets and income is from the financial domain are allowed to setup banks. But large industrial houses are not yet allowed to setup banking business.

RBI’s Proposal on Industrial Houses

The internal working group of RBI headed by P.K. Mohanty has recommended that large corporate or industrial houses having total assets of Rs 5,000 crore or more may be allowed as promoters of banks. This proposal can be implemented only after making amendments to the Banking Regulation Act, 1949.

Need for Corporates and Industrial Houses in Banking

Even after three decades of growth after liberalization reforms, the total balance sheet of banks in India still constitutes less than 70 per cent of the GDP, which is very less as compared to countries such as China where it is nearly 175%.

• Domestic bank credit to the private sector is just 50% of the total GDP as compared to China, Japan, USA, etc. where it is more than 150%.
• There is only one Indian bank in the top 100 global banks by size. Cost efficiency of Indian banking system is very low.
• To achieve the targets of a $5 trillion economy, capital intensive sectors need huge capital infusion and the people need access to efficient banking services.
• Recapitalisation using taxpayer’s money for correcting capital adequacy of banks is inefficient and does not address the core issues.

Advantages

Allowing large industrial houses to own banks will lead to large capital infusion in the banking industry. It will bring the hitherto untapped domestic sources of capital into the banking sector for lending.

• Improvements in the lending ability of banks will also give a push to the economic recovery, the benefits of which will reach the poor and downtrodden section of the society with trickle down.
• It will further improve competition amongst the Public sector banks and existing private sector banks, thereby increasing their efficiency.
• Large capital infusion will also reduce pressures on the fiscal deficit of the government as a significant amount of taxpayer’s money will be saved in the form of bank recapitalization.
• It will bring the corporate and industrial expertise into banking and improve banking standards. With new lending and credit evaluation models, there will be productivity and financial gains.

Challenges

Concerns were raised regarding the proposal by various experts. The following challenges emerge-

• A greater play of private banks is not without its risks. The global financial crisis of 2008, largely driven by private sector lending is a case in point.
• A predominantly government-owned banking system tends to be more financially stable because of the trust in government as an institution.
• The main concern in allowing large corporates to open their own banks is conflict of interest which can manifest in the form of “connected lending”.
  • Connected Lending refers to a situation where the promoter of a bank is also a borrower and, as such, it is possible for a promoter to channel the depositors’ money into their own ventures.
  • Connected lending has been happening for a long time and the RBI has been always behind the curve in spotting it. The recent episodes in ICICI Bank, Yes Bank, DHFL etc. were all examples of connected lending.
  • The ever-greening of loans (where one loan after another is extended to enable the borrower to pay back the previous one) is often the starting point of such lending.
• Corporate sector owning banks will give more power to big industry groups, which already dominate important sectors of the economy, such as telecom, fintech, e-commerce, etc.

The fact that Banking Industry in India is highly stressed requiring an overhaul cannot be ignored. The Government and RBI should weigh down the costs of the proposal against the intended benefits.