Allowing Corporates to own Bank

The Reserve Bank of India’s (RBI) internal working group on Friday recommended allowing large companies to set up banks and awarding banking licences to well-managed non-banking financial companies (NBFCs). The RBI panel has recommended that corporates should be allowed to control banks after necessary amendments to the Banking Regulation Act, 1949 to prevent connected lending and exposures between the banks and other financial and nonfinancial group entities.  

• In addition, the group proposed strengthening of the supervisory mechanism for large conglomerates. 

Internal Working Group (IWG) recommendations:

• To allow large corporate and industrial houses to promote and run banks in India. “Large corporate/industrial houses may be permitted to promote banks only after necessary amendments to the Banking Regulation Act, 1949.
• Since the nationalisation of 14 large private banks in 1969, the RBI has not given licenses to large corporate and industrial houses for setting up banks. At present, there are 12 old and nine new private banks (established in the post-1991 period) with the majority of ownership held by individuals and financial entities.
• Another important recommendation of the IWG is to allow conversion of large non-banking financial companies (NBFCs), including those owned by corporate houses, with assets of Rs 50,000 crore and above and 10 years of operations into full-fledged banks.

Why recommend it?:

• The Indian economy, especially the private sector, needs money (credit) to grow. Far from being able to extend credit, the government-owned banks are struggling to contain their non-performing assets.
• Government finances were already strained before the Covid crisis. With growth faltering, revenues have plummeted and the government has limited ability to push for growth through the public sector banks.
• Large corporates, with deep pockets, are the ones with the financial resources to fund India’s future growth.

Benefits:

• Allowing the big corporates into the banking sector the capital requirement can be fulfilled.
• The opening of more branches and subsequently bringing more people into the banking net.
• Privatization of banks has been a long-proposed reform in the Indian banking industry. Allowing corporates into the banking sector will further pressurize Public sector banks to become competitive.

Concern:

• The working group’s concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks.
• Corporate ownership of banks raises the risk of intergroup lending, diversion of funds, and reputational exposure.
• Also, the risk of contagion from corporate defaults to the financial sector increases significantly.
•  The banking sector in India has been in trouble for the last few years, keeping that in mind the RBI in 2016 had created new guidelines on the limit of lending to a single company.
• Inequality & Concentration of Wealth
•  Another risk associated with banks owned by industry groups is circular lending.
• A bank with no connections to business houses can effectively screen loan applicants and thus ensure efficient allocation of funds to accelerate the overall growth of the economy.

Conclusion:

• If the RBI accepts this recommendation, it would lead to a backdoor entry of corporate-owned NBFCs into the banking space.
• The IWG’s recommendations are unexceptionable in that they bolster prudential norms so that the interests of the depositors are secure and banks and their promoters are not able to game the system