NEW DELHI: The Reserve Bank of India (RBI) proposal to allow large corporate houses creating banks is a “bomb”, former RBI governor Raghuram rajan and former lieutenant governor Viral Acharya wrote in a joint article Monday.
Emphasizing the need to adhere to tried and true limits on business involvement in banking, the duo said the recent proposal “is best left on the shelf.”
The article posted on Rajan’s LinkedIn profile noted that the RBI’s internal working group (IWG) has suggested significant amendments to the Banking Regulation Act of 1949, aimed at increasing the RBI’s powers, before allowing corporate companies to enter the bank.
According to them, there are two main reasons for not allowing industrial houses to enter banking. First, they questioned how banks can make good loans when they are owned by the borrowers themselves.
“The history of these types of connected lending is invariably disastrous: How can the bank make good loans when it is owned by the borrower? Even a committed independent regulator, with all the information in the world, has a hard time being in every corner of the system financial support to stop poor loans. Information on loan performance is rarely timely or accurate, “the article reads.
Additionally, they noted that RBI’s group exposure rules that limit the amount of exposure the banking system can have to specific industrial houses were also recently relaxed. “Furthermore, as the WGI suggests, it is always difficult to discern the connections that make a borrower part of an industrial house. Some of the favored ones are happily expanding, financing asset purchases with more loans, imposing greater risks on the system.” . He said.
Second, they were of the opinion that the entry of private actors into banking should be prohibited, since it will further exacerbate the concentration of economic (and political) power in certain business houses.
“Even if bank licenses are allocated fairly, it will give an undue advantage to large business companies that already have the seed capital to contribute. Additionally, highly indebted and politically connected business companies will have the greatest incentive and ability to drive forward. licenses, “they noted.
Last week, an RBI panel proposed allowing large corporations to promote banks, as well as raising the limit on promoters’ participation in private sector banks to 26%, from the current 15%.
The RBI panel had recommended that companies be allowed to control banks after necessary amendments to the Banking Regulation Act of 1949 to avoid connected loans and exposures between banks and other financial and non-financial group entities. In addition, the group also proposed to strengthen the supervisory mechanism for large conglomerates.
Rajan and Acharya also said that, as in many parts of the world, Indian banks can rarely fail – the recent rescue of Yes Bank and Lakshmi Vilas Bank are examples. For this reason, depositors in regular banks know that their money is safe, which makes it easier for banks to access a large volume of depositors’ funds.
“However, if strong regulation and supervision were just a matter of legislation, India would not have an NPA problem. It’s hard not to see these proposed amendments as a subtle way for the IWG to undermine a recommendation that it may have had little power.
“In summary, many of the technical rationalizations proposed by the IWG are worth adopting, while their main recommendation, allowing Indian corporate companies to enter banking, is best left on the shelf,” they stated.
(With contributions from the agency)
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