Allowing corporate houses to own banks could be disastrous: Raghuram Rajan & Viral Acharya

MUMBAI: Former Reserve Bank of India (RBI) governor Raghuram Rajan and Viral Acharya, who used to be deputy governor, opposed the proposal by a central bank panel to let industrial houses set up banks, describing this as a “bombshell.” Allowing corporate houses into the banking system could intensify the concentration of political and economic power in the hands of a few business houses, they said.
“Industrial houses need financing, and they can get it easily, with no questions asked, if they have an in-house bank. The history of such connected lending is invariably disastrous — how can the bank make good loans when it is owned by the borrower?” Rajan and Acharya said in the joint article posted on the former’s LinkedIn page.

Questions over Proposal’s Timing
“Highly indebted and politically connected business houses will have the greatest incentive and ability to push for licences. That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism,” they added.

An RBI working group that reviewed ownership norms suggested that big business houses be allowed to set up banks after amending the Banking Regulation Act, in recommendations unveiled on Friday. The central bank has been reluctant to do so because of worries over governance, conflict of interest, misallocation of credit and concentration risks. During Rajan’s time as governor, corporate houses were allowed to seek universal bank licences in 2013 but none were awarded to them.

The writers questioned the timing of the move.

“Why is there urgency to change the regulation? After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?” Rajan and Acharya said. “Interestingly, the internal working group reports in its appendix that all the experts it consulted, except one, ‘were of the opinion that large corporate/industrial houses should not be allowed to promote a bank.’ Yet it recommends change!”

Regulatory Independence at Stake
They also raised the question of regulatory independence.

“Can the regulator not discriminate between ‘fit and proper’ businesses and shady ones? It can, but it has to be truly independent, with a thoroughly apolitical board,” they said. “Whether these conditions will always pertain is debatable.”

Rajan and Acharya also argued against shortening the time taken for payment banks to be converted into full-fledged banks. The committee recommended reducing this to three years from five. In the last year, payment banks run by Paytm and Reliance Jio Infocomm have expressed interest in becoming small finance banks.

“A second possibility is that an industrial house holding a payment bank licence wants to transform into a bank,” the two former central bankers said. “One recommendation of the internal working group that is equally hard to understand is to shorten the time for such transformation from five to three years, so perhaps the surprising recommendations have to be read together.”

Among the possible reasons for such a move could be the government wanting to expand the universe of bidders for possible privatisation of public sector banks.

“It would be a mistake, as we have said in an earlier paper, to sell a public sector bank to an untested industrial house,” said Rajan and Acharya. “Far better to professionalise public sector bank governance, and sell stakes to the broader public — that would help promote a shareholder culture, as well as distribute wealth more widely.”

‘Higher Bailout Costs’
They said the bill for a rescue will be much higher if a bank led by an industrial house fails.

“Once the bank licence is given, the licensee’s temptation will be to misuse it because of self-lending opportunities,” the duo noted. “India has seen a number of promoters who passed a fit and proper test at the time of licensing turn rogue. The bailout costs to the exchequer could be significantly more when it comes to bank licences to industrial houses, which will start out big.”

They pointed out that the report has been issued when three lenders, including two scheduled commercial banks, have failed in the past year. Yes Bank was bailed out by a group of institutions including State Bank of India while Lakshmi Vilas Bank is proposed to be taken over by the local subsidiary of Singapore-based DBS Bank. As for the bankrupt Punjab and Maharashtra Co-operative Bank, a number of depositors are yet to get their money back.