Proposal to allow corporates into banking a bombshell: Raghuram Rajan, Viral Acharya

Cornelia Mascio
Novembre 24, 2020

In the note, Rajan and Acharya have questioned the timing of the move, stating that nothing has changed to warrant a fresh stance of the RBI to grant bank licences to corporate houses.

"While the [RBI internal working group's] proposal is tempered with many caveats, it raises an important question: Why now?"

"Why now? Have we learnt something which allows us to override all the prior cautions on allowing industrial houses into banking?" the former regulators who had testy relations with the Narendra Modi government said in a joint article on professional networking site LinkedIn. "We would argue no", they opined.

Terming the recommendation a "bombshell", former RBI governor Rajan and deputy governor Viral Acharya said the banking regulator needs to tread this path with caution, especially after the near-collapse of Infrastructure Leasing and Financial Services (ILFS) and Yes Bank in the past year. When the industrial houses would need financing, they would get that without any question from the banks floated by them.

Another crucial reason why industrial houses should not be entertained is a banking license will concentrate the economic and political powers with certain business houses.

Rajan and Acharya observed that the history of connected lending is invariably disastrous - how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it hard to be in every nook and corner of the financial system to stop poor lending. "Yes Bank managed to hide its weak exposures for considerable periods", the post pointed out.

Moreover, regulators can succumb to either political pressure or the urgency of the moment, they added. "Some favoured ones are expanding merrily, financing asset purchases with yet more borrowing, imposing greater risks on the system", the authors said.

"Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up".

Allowing the entry of corporates into banking will mean that highly indebted and politically connected business houses will have the greatest incentive and ability to push for licences, they added. "That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism", the duo noted. Besides, after getting the license, the licensee would likely want to misuse it with an intention to self-lend. "India has seen a number of promoters who passed a fit and proper test at the time of licensing turn rogue", the duo note.

The IWG, which released its report last week, admitted that "all the experts except one were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank". "Is there some dramatic change in perception that it is responding to?", they wondered. Rajan and Acharya ask that if that's the case, then "why not encourage more of these less-conflicted houses to apply for a licence?"

This objective is better achieved by professionalising governance and letting the broader public own larger stakes in these banks, they argued. This allows telecoms and possibly internet platforms to offer deposit accounts. "Why again do we need industrial houses to get full-fledged bank licenses?"

The authors said it would be a mistake to sell a PSB to an untested industrial house.

"Yet it recommends change!", they pointed out.

The approach of the RBI regarding ownership of banks by large corporate/ industrial houses has, by and large, been a cautious one in view of serious risks, governance concerns and conflicts of interest that could arise when banks are owned and controlled by large corporate and industry houses.

"A second possibility is that an industrial house holding a payment bank license wants to transform into a bank", said Rajan and Acharya.

"One recommendation of the IWG 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", Rajan and Acharya said.

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