Banks: Governance, not ownership, is key

One sentence from a recent internal committee report of Reserve Bank of India — “large corporate/industrial houses may be allowed as promoters of banks” — has generated an intense debate. To put it a little simplistically, those in favour of the suggestion argue that this will bring much-needed capital and competition while those against it claim this will lead to promoters lending bank funds to themselves and create further problems for the ailing Indian banking industry.

India’s banking history explains this divided response, with many episodes of industry-promoted banks lending to themselves. One major reason for India’s bank nationalisation in 1969 was industry’s control over banks. The then Prime Minister Indira Gandhi listed “the removal of control by a few” as one of the major reasons for nationalisation. She further added that by “severing the link between the major banks and the bigger industrial groups which have so far controlled them”, the government will be able to professionalise the banking sector. Ever since then, we have been uncomfortable with corporates owning banks.

However, history is also replete with banks promoted by professionals lending irresponsibly to bring ruin. Let us review private bank licences since 1994. We choose 1994 since after bank nationalisation, no new private banks were licensed and new private banks were allowed only post-1991 reforms. Fourteen new banks have been licensed in three stages since 1990s. Of the 14, financial institutions and professionals have promoted five banks each. Two banks were promoted by corporates and two others were set up with the conversion of non-banking financial company (NBFC) and Cooperative Bank. RBI has clearly preferred professionals and institutions for new banks.

Of the 14 banks, four have been merged and two were in financial trouble but were bailed out by financial institutions. Amid the banks which have avoided trouble, those promoted by financial institutions have been stable. Out of the six failed/merged/troubled banks, four were run by professionals, one by a financial institution and one by a corporate. Clearly, professionals have not fared on expected lines.

Those in favour of corporate-promoted banks will point to case of Indusind Bank which has been promoted by the Hindujas. Those against will point to case of Times Bank. But more than the nature of ownership, this shows that it boils down to the kind of corporate governance the promoters have established with checks and balances in place.

In this backdrop, how does one assess the new recommendation? To be fair, the report has added riders before allowing corporates as promoters. First, the Banking Regulation Act (1949) has to be amended so that such banks can avoid connected lending and exposures between the banks and other financial and non-financial group entities. Second, it will require strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision.

Thus, it is hardly a blanket case where any industrialist applying to be a promoter will be allowed. Moreover, RBI has a very stringent “fit and proper criteria” which makes it very difficult for anyone to get a bank licence. Even in 2013, several top corporates had bid for universal bank licence but only IDFC and Bandhan were given the licence. Having said that, corporates were allowed to start payment banks which mainly facilitate payments and not give loans. But it was then treated as a reform despite critics pointing that payment banks could give a backdoor entry for corporates. Former RBI officials themselves point out that payment banks can tie up with other banks to provide loans. However, they see it as a reason for corporates to not be considered for a bank licence. But why would you be comfortable with indirect lending and not direct lending?

To sum up, there are reasons to be divided on the issue. While the criticism against corporates as promoters has merit, the argument that they will lend funds to themselves is rather naïve. RBI gets regular reports on bank lending and this can be ruled out as must be the case with Indusind bank. A corporate-promoted bank will be worried about its reputation and think very hard before flouting the law.

A bigger risk is this policy could lead to concentration of a few large players dominating banking as well, leading to lower competition and not higher competition as is desired by the policy. But then where and how does India get funds for new and large banks? The report also pointed out how India lags behind others in terms of credit as a percentage of GDP and has only one bank in the top global 100 banks. One way out could be opening up more space for foreign banks, but partly due to the lessons of 2008 crisis, there has been caution in doing so. There is, however, a tiny step forward in allowing Singapore based DBS India to take up Lakshmi Vilas Bank (LVB).

It may be prudent to moderate expectations from our banks and banking policy. India should relax some of the constraints. This will allow larger, sustainable banks — for will a Tata Bank be such a bad idea? Or there has to be a conscious decision to allow the mushrooming of smaller banks across the country, which comes with its own risks.