Should corporate houses ‘own’ banks?

In an anatomical sense, money is the blood in an economy and banking system is its heart. This analogy stands true not just in the sense that banks pump money with a multiplier effect in the economy, but also because of how critical they are to the overall health of the economy. The collapse of a single major bank would cause a spill-over effect over the entire economy triggering social externalities as witnessed during the global financial crisis in 2008. It is therefore understandable that central banks across the world monitor the health of the banks so closely by way of reporting and reserve requirements.

Banking in India

Apart from the intermediation of funds, the financial sector, particularly banks also have a tremendous welfare potential by way of equitable distribution of resources across sectors and regions. However, at the time of India’s Independence, the banking sector was dominated by private banks due to which money supply was largely concentrated only to few urban pockets, exacerbating the inequalities. Government of India, by way of bank nationalizations in 1969 and 1980 took over 20 of the largest private banks to bolster rural credit growth by setting up branches in remote locations. It was only along the wave of 1991 reforms that new licenses were issued to private players and banks like HDFC and ICICI came into being.

Since 1969, India has grown significantly to become the 5th largest economy in the world. However, India’s banking sector is disproportionately under-developed given the size of its economy with only one bank in the top 100 global banks. Further, Public Sector Banks (in the likes of SBI), even after three decades since reforms, continue to hold a whopping 70% of the market share in India. Yet, on every count (like gross NPAs, capital adequacy ratios or market capitalization) PSBs are inefficient and are clearly value destroyers.

Indian economy is therefore like a fully grown human body with disproportionately small as well as an ailing heart.

Recommendation by the RBI’s Internal Working Group (‘IWG’) and the risk therein

Although private licenses were issued after 1993, corporate houses like Tatas and Birla were restricted from owning their own banks (cap of 15% shareholding). Broadly, the main concerns of allowing large corporate houses to own banks relate to conflicts of interest (banking vs other business aspirations, connected lending, intra- group transactions), increased risks of misallocation of credit (lending to their own poor performing businesses which otherwise cannot raise capital) as well as the concentration of economic power and anti-competitive practices.

The IWG report while acknowledging the risks posed by corporate ownership of banks, it pointed out that the entities can be an important source of capital along with their experience, management expertise and strategic direction to banking. This understandably sparked off a debate in the policy circles with former RBI Governor, Dr. Raghuram Rajan and Deputy Governor Viral Acharya criticizing the move as “Penny wise Pound Foolish”.

In their note, Rajan and Acharya question the very timing of the move — “Why now?”, especially when the existing supervision itself is not fully in order and wounds from mismanagement of Yes Bank and IL&FS are still fresh. They argue that “highly indebted and politically connected business houses” will have the greatest incentive and ability to push for new banking licenses, a move that could make India more likely to succumb to “authoritarian cronyism”.

Point of difference

I fully agree with this note that India’s banking system still has many gaps to fix. Further, given that the very independence of RBI from the government’s interference, there is an urgent need for RBI to put its own house in order. To be fair, IGW recommendation fully acknowledges the risks and proposes coherent regulations to overcome these risks. However, should we shelf the idea even without trying? I disagree. My argument is based on three misplaced issues: Inherent mistrust on all corporate houses, uncalled for pessimism and lack of a vision.

a) Inherent mistrust — While crony capitalism exists, casting an aspersion of mistrust on all corporate houses is a self-goal! For example, the note points that, “India has seen number of promoters who passed fit & proper test at the time of licensing but then turned rogue”. One should not forget that eminent corporate houses like Infosys significantly contributed to the corporate governance practices in India. First, you would be surprised to know that Infosys is a debt-free company. Not all corporates need to be conflicted. Second, companies like Grasim has credit rating better than PSBs like BOB, BOI, Canara Banks. Third, these business houses demonstrated success in their respective fields and there is no reason to believe they would not be successful in banking. Lastly, considering that their well -established brand value is at stake, it would cost them too dearly to do anything unlawful in an industry that is so closely monitored.

Also, corporate houses own NBFCs including mutual funds which operate a massive size of pubic investments already. Mutual fund industry grew exponentially in the last two decades and the corporate houses that own them not only comply with existing rules but also enjoy public confidence.

b) Uncalled for pessimism — It is upsetting that distinguished economists like Rajan undermine the power of legislation. To paraphrase them “if sound regulation and supervision were only a matter of legislation, India would not have an NPA problem”. In my opinion, this seems to be an overstretch

• First, unfortunate incidents like PMC, Yes Bank and IL&FS, should have been avoided in the first place with inherent checks and balances. However, outliers like these happen in any economy, including in the developed world and are only set-backs in larger scheme of things. Is it not true that rest of the banking system is functioning fine under and withstood jolts like 2008 crisis as well as Covid pandemic? In fact, it is the present supervision mechanism that averted Yes Bank from collapsing. Why not see this through a positive lens?
• Second, NPA crisis today is due to several factors including poor governance in the past and it has taught us lessons for the future. For example, The Banking and Insolvency Code was legislated to address the NPA menace among other things and we are already witnessing early gains in terms of reduced NPA% and improved loan recoveries.
• Lastly, few of the risks associated with corporate ownership are already existing. For example, in the case of Jio, there was a concentration of power but at the same time, it also brought renewed push for digital penetration in India along with market corrections. We only need to ensure a fair play of competition through existing laws.

c) Lack of vision — A collaboration with tech giants like TCS or Infosys could go a long way in helping India achieve its financial inclusion goals. South Korea, for example, has recently come up with its zero- branch bank. Similarly, FMCG brands have last-mile connectivity to remote areas and their understanding of rural economy could help in reaching out with appropriate banking products.

While there are definite risks associated with the proposed move, a tad of optimism and tightening of supervision could work wonders. We may not be ready yet, but if we shelf the idea altogether, we will never be able to put the house in order. Instead, we should at least experiment. HDFC bank, the most valued bank of India would not have seen light if we had allowed our fears from the past to haunt us. India today has a great window of demographic dividend and it is time we attempt some bold moves to build a resurgent economy. Let us not leave a single avenue whether foreign investments, non-banking channels or even tapping deep pockets of our Industrialists to push the financial sector to greater heights.