Banking Sector Reforms

Allowing corporate houses in banking

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NBFCs

Mains level : Paper 3- Banking regulation and allowing corporate houses to own banks

The article argues against the suggestion of allowing the corporate houses in the banking sector in India.

Context

  • An Internal Working Group of the Reserve Bank of India (RBI) has recommended that corporate houses be given bank licences.

Background of the idea

  • In February 2013, the RBI had issued guidelines that permitted corporate and industrial houses to apply for a banking licence.
  • No corporate was ultimately given a bank licence.
  • None of the applicants had met ‘fit and proper’ criteria.
  • In 2014, the RBI restored the long-standing prohibition on the entry of corporate houses into banking.
  • The RBI’s position on the subject has remained unchanged since 2014.

Advantages

  • Corporate houses will bring capital and expertise to banking.
  • Moreover, not many jurisdictions worldwide bar corporate houses from banking.

Risks involved

  • As the report notes, the main concerns are interconnected lending, concentration of economic power and exposure of the safety net provided to banks
  • Corporate houses can easily turn banks into a source of funds for their own businesses.
  • In addition, they can ensure that funds are directed to their cronies.
  • They can use banks to provide finance to customers and suppliers of their businesses.
  • Adding a bank to a corporate house thus means an increase in concentration of economic power.
  • Not least, banks owned by corporate houses will be exposed to the risks of the non-bank entities of the group.
  • If the non-bank entities get into trouble, sentiment about the bank owned by the corporate house is bound to be impacted.

Suggestion by IWG and issues with them

  • The Internal Working Group (IWG) believes 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.
  • But there are following 4 issues with such suggestion-
  • 1) Tracing interconnected lending will be a challenge.
  • 2)The RBI can only react to interconnected lending ex-post, that is, after substantial exposure to the entities of the corporate house has happened.
  • It is unlikely to be able to prevent such exposure.
  • 3) Any action that the RBI may take in response could cause a flight of deposits from the bank concerned and precipitate its failure.
  • 4) Pitting the regulator against powerful corporate houses could end up damaging the regulator.

Issues in allowing NBFC owning corporate house in banking

  • Under the present policy, NBFCs with a successful track record of 10 years are allowed to convert themselves into banks.
  • The Internal Working Group believes that NBFCs owned by corporate houses should be eligible for such conversion.
  • This promises to be an easier route for the entry of corporate houses into banking.
  • The Internal Working Group argues that corporate-owned NBFCs have been regulated for a while.
  • However, there is a world of difference between a corporate house owning an NBFC and one owning a bank.
  • Bank ownership provides access to a public safety net whereas NBFC ownership does not.
  • The reach and clout that bank ownership provides are vastly superior to that of an NBFC.
  • The objections that apply to a corporate house with no presence in bank-like activities are equally applicable to corporate houses that own NBFCs.

Consider the question “What are the concerns and challenges in allowing the corporate houses in the banking sector in India?” 

Conclusion

India’s banking sector needs reform but corporate houses owning banks hardly qualifies as one. If the record of over-leveraging in the corporate world in recent years is anything to go by, the entry of corporate houses into banking is the road to perdition.

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