Corporates As Bankers: Not a Bankable Idea

RBI has moved beyond the normal terms on promoters' eligibility and net worth and has set a minimum threshold on assets requirement and operational record

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With an intention of introducing comprehensive transformations in the banking sector, the Reserve Bank of India’s (RBI) internal working group (IWG) responsible for appraisal of corporate configure of private sector banks has decided to permit big corporate and industrial outfits to own banks. According to reports, business firms can openly apply for license or those dealing in lending activities can transmute their prevailing businesses to a bank.

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Two crucial stipulations have been introduced by the working group to support corporate entry into banking. One of them is the amendment of the provision of the Banking Regulation Act, 1949 which deals with connected lending and exposures between banks and other financial and non-financial group units. According to Section 20 of the Banking Regulation Act, banks cannot provide any loans or advances to its directors. Secondly, to reinforce the RBI’s guiding method for large companies, the group has recommended that the regulator of banks may scrutinize the relevant judicial provisions to prepare itself for the mammoth task. If the suggestions of the group get green signal, this will mark the re-entry of India Inc. into banking after four decades after the last round of bank nationalization in 1980.

For the first time the watchdog has moved beyond the normal terms on promoters’ eligibility and net worth and has set a minimum threshold on assets requirement and operational record. The group has proposed to allow large non-banking financial companies (NBFCs) having at least 10 years’ record with an asset size more than INR 50,000 crore including those within the fold of business firms to convert to banks. In addition, non-operative financial holding company (NOFHC) structure has to be adopted by the NBFCs with varied business activities. Accordingly, entities such as Bajaj Finserv, Aditya Birla Capital and Tata Capital, which also have insurance and asset management activities have to rearrange their corporate edifice.

Various industrial consortiums aiming to enter the commercial banking zone since 1993 ever since private players were permitted into banking. In 2008, the Committee on Financial Sector Reforms led by Raghuram Rajan strongly rejected the admission of corporate businesses into banking and observed that exclusion is necessary like in the US. The committee also declared that up until private governance and governing capability progress, the prohibition is needed.

In 2012, many NBFCs supported by outsized industrial establishments showed interest for banking permits. Bajaj Finserv, M&M Finance, Tata Capital, L&T Financial Holdings, Aditya Birla Capital, Shriram Transport, Cholamandalam Investments and Finance, Muthoot Finance are the few NBFCs who demonstrated high level interest for banking licenses.

Despite the fact RBI had allowed corporate and industrial units to apply for a banking permit in 2013 no corporate body was given the permission because they did not meet fit and proper standard. Only two organizations namely IDFC and Bandhan Financial Services were nominated for a license. The apex bank reinstated the time-honored ban on the entry of corporate establishments into banking in 2014 and the RBI’s viewpoint on the theme remained same since then.

Bolt from the blue

The propositions of the IWG of the RBI have created tremor amongst brainy banking leaders and wizards like former RBI governor and deputy governor Raghuram Rajan and Viral Acharya, have labeled it as a ‘bombshell’. Moreover, countless credible voices have upheld their opinion. Primarily many problematic issues like inherited distrust in the banking sector and irrepressible weaknesses of the regulator’s ability and autonomy made them to act so.

The foremost disagreement towards the proposal is that business firms obviously stage-manage the system and stakeholders’ wealth since these firms could get finance effortlessly and without any interrogations if they have in house bank. Of late, the banking sector has witnessed plentiful incidences of failure of public and private sector banks due to the greediness and untruthfulness of persons controlling the banks, with dangerous upshots to shareholders and depositors. Adjoining a bank to corporate entity definitely augment the intensity of economic power just like how politicians have utilized banks to promote their political interests. By owning bank corporate houses will tantalized to misuse the funds by diverting them to their buddies, cronies, customers or suppliers. Although many firms have power to run banks but they do not stimulate assurance when it comes to governance.

Secondly, business establishments may transmit funds domestically and globally through large network of firms. Because of this feature, supervising the financial transactions of the business firms, locating interrelated lending will be difficult. This situation will necessitate the support of numerous law prosecution bureaus and business entities may use their political influence to prevent such cooperation. Even though the group suggested that the RBI should be armed with necessary legal power to deal with interconnected lending and procedure, with reference to Indian setting, it is foolish to assume that any legal outline and administrative system will be sufficient to deal with the intrinsic threats of interrelated lending. The reaction of the RBI to interconnected lending after significant exposure to the firms of the business houses has ensued, will not be able to check such exposure and it will be like post-mortem.

Thirdly, hostility between RBI and the corporate entities will damage the image of the regulator. Moreover, the regulator may have to face massive pressure to compromise on rules and regulations. As a result it may lose the reliability and its prominence will be in danger.

Fourthly, public sector banks are in dire need of capital that the government is incapable to give and the entry of corporate players probably to be a prologue to privatization. Also the valuations of the public sector banks have tattered in current years and this is the real attraction for business firms to acquire them. Considering what we know of governance in the Indian corporate sector, purchase of public sectors by corporate houses will jeopardize the financial solidity.

Lastly, the group contends that terms pertaining to the entry of corporate players who owns NBFCs into banking should be eased because the RBI knows well about the NBFCs owned by corporate entities and controlled them professionally. This is clearly misleading and hypocritical because there is a big gap between corporate owning a NBFC and one possessing a bank. Bank possession offers access to public protection net whereas NBFC possession not. The reach and power that bank ownership offers are widely excellent to that of a NBFC. Therefore, the restrictions that apply to a corporate firm with no presence in banking industry should similarly applicable to corporate firms that own NBFCs.

As a final point, the RBI’s Internal Working Group’s recommendation to sanction corporate business units to establish banks and amendment of the Banking Regulation Act is a step in harmful way. This will surely give birth to crony capitalism and fiscal uncertainty. The RBI should learn lessons from East Asian’s bad loans crisis which was one of the biggest financial crashes in the world that started in Thailand in 1997 due to connected lending. Thus, corporate entities possessing banks barely meet the benchmark of strong restructurings and their entry into banking is the avenue to hell. The Apex bank needs to shrewd and should design power-packed reforms urgently needed for the Indian banking sector. It should reveal its smartness through action, not reaction. An arrangement of accurate and strict safeguards will need to be put in place before the central bank allows billionaires to start banks in its wonderland.

Shivanand Pandit

Written By

He is a tax specialist, financial adviser, guest faculty and public speaker based in Goa. He can be reached at panditgoa@gmail.com