The article analyses the risks involved in allowing the corporate houses to own and operate the banks.

Context

• An internal working group of the RBI has recently made a recommendation to permit industrial houses to own and control banks.

Encourage bank but not owned by banks

• According to the report, the main benefit is that industry-owned banks would increase the supply of credit, which is low and growing slowly.
• Credit constraints are indeed a real problem, and creating more banks is certainly one way of addressing the issue.
• But this is an argument for encouraging more banks but it is not an argument for creating banks specifically owned by industry.
• The other powerful way to promote more good quality credit is to undertake serious reforms of the public sector banks.

Problems in allowing industrial houses in banking

• The problem with banks owned by corporate houses is that they tend to engage in connected lending.
• This can lead to three main adverse outcomes:

1) Over-financing of risky activities

• Lending to firms that are part of the corporate group allows them to undertake risky activities that are not easily financeable through regular channels.
• Precisely because these activities are risky, they often do not work out.
• And when that happens, it is typically taxpayers who end up footing the bill.
• In principle, connected lending can be contained by the regulatory authority.
• However, experiences in other nations show that regulating connected lending is impossible convincing most advanced countries that regulating connected lending is impossible.
• Indonesia tried to regulate the practice: It banned the practice.
• The only solution is to ban corporate-owned banks.
• Regulation and supervision need to be strengthened considerably to deal with the current problems in the banking system before they are burdened with new regulatory tasks.

2) Lack of exit

• The economic landscape is littered with failed firms, kept alive on life support, making it impossible for more efficient firms to grow and replace them.
• While some progress was initially made under the Insolvency and Bankruptcy Code (IBC), this had stalled even before the pandemic, largely because existing promoters and owners mounted a stiff resistance.
• If industrial houses get direct access to financial resources, their capacity to delay or prevent exit altogether will only increase.

3) Increasing dominance

• The Indian economy already suffers from over-concentration.
• We not only have concentration within industries, but in some cases the dominance of a few industrial houses spans multiple sectors.
• If large industrial houses get banking licences, they will become even more powerful, not just relative to other firms in one industry, but firms in another industry.

Impact on regulator and government

• The power acquired by getting banking licences will not just make them stronger than commercial rivals, but even relative to the regulators and government itself.
• This will aggravate imbalances, leading to a vicious cycle of dominance breeding more dominance.

Impact on quality of credit

• Indian financial sector reforms have aimed at improving not just the quantity, but also the quality of credit.
• The goal has been to ensure that credit flows to the most economically efficient users, since this is the key to securing rapid growth.
• If India now starts granting banking licences to powerful, politically connected industrial houses we will effectively be abandoning that long-held objective.

Impact on economy and democracy

• Indian capitalism has suffered because of the murky two-way relationship between the state and industrial capital.
• If the line between industrial and financial capital is erased, this stigma will only become worse.
• Corporate houses that are already big will be enabled to become even bigger allowing them to dominate the economic and political landscape.
• A rules-based, well-regulated market economy, as well as democracy itself — will be undermined, perhaps critically.

Consider the question “What are the challenges and opportunities in allowing the industrial houses to own and operate the banks.”

Conclusion

The conclusion is clear. Mixing industry and finance will set us on a road full of dangers — for growth, public finances, and the future of the country itself.

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The article deals with the recent NPCI decision to cap the number of transactions by third party application providers (TPAPs).

Context

• The National Payments Corp of India (NPCI), in its recent guidelines imposed a 30% volume-based cap on the share of transactions by TPAPs and payment service providers (PSPs), effective from January 2021.

 5 issues with the volume-based cap

1) It undermines cashless economy

• The growth and recognition of UPI would not have been possible had a cap been in place.
• Typically, customers limit themselves to one or two TPAPs of their choice.
• A transaction cap that forces users to use multiple apps may result in more transaction failures and dilute UPI’s popularity and impact.
• Lack of accessibility and user-friendliness would push users away from UPI towards other payment methods, or even cash.

2) It’s an anti-consumer decision

• Open markets and user choice have been crucial factors in the exponential increase seen in UPI adoption and its transactions.
• A volume-based cap would compel TPAPs to either limit the number of transactions on their platforms or stop enrolling new users, which in turn would restrict the customer’s use of UPI.
• TPAPs will likely be forced to redact customer incentives like cashbacks, coupons and the like.
• This could go against consumer interests by reducing choice.

3) It will also make the Indian market less attractive for investors:

• The cap would raise compliance and regulatory costs for players in the sector, which could deter new investors from entering.
• It would also adversely affect the growth potential of existing UPI players.

4) No regulatory impact assessment

• The idea of a volume-based cap does not appear to have undergone an assessment of its impact on the sector.
• As a general principle, before any such rule is imposed, an RIA (Regulatory Impact Assessment) needs to be undertaken.
• Systemic risks are not restricted to UPI and are common in all financial systems; yet, a similar cap has not been suggested for, say, retail bank transactions.

5) Impact on Atmanirbhar Bharat

•  In order for Indian businesses to grow and compete at the global level, we need to integrate business processes with the global economy.
• Indian start-ups, in particular, need tools and infrastructure that lets them gain an international edge.
• Atmanirbhar Bharat envisions a self-reliant India that thrives on innovation, technology and entrepreneurship.
• But this vision cannot be fulfilled if our policies restrain the growth of a cashless economy.

Conclusion

India’s UPI ecosystem is nascent, but has demonstrated significant growth and has had a positive impact on the economy by providing the backbone needed to move towards cashless commerce. Any policy decision by regulators at this point should aim at catalysing innovation in this space. Stifling it would serve India badly.

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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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