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New banking licences make no sense: Percy Mistry

'I do not think large industrial houses should be allowed to run banks'

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Former World Bank economist Percy Mistry, who authored a widely acclaimed  report on making Mumbai an international financial centre,  says state-run financial institutions need drastic changes in their working and the government should draw up a strategy to exit these institutions. Edited execrpts from an interview with Dev Chatterjee & Abhijit Lele.  

After a lot of time, there is some clarity emerging in policy making. What’s your take on the recent policy changes?

India had lost all credibility following prolonged macroeconomic mismanagement between mid-2009 and mid-2012. Thank God, Mr Chidambaram is back. We seem to be on the right track again. However we are not out of the woods by any means. For example, it was shocking to hear the kind of arguments made during the debate on FDI in retail and on the banking bill. I wonder whether the political class in India at the Centre and in the states is aware of economic realities as they are today.

After last year’s anti-investor moves like GAAR, the vendetta conducted against Vodafone, and a series of corruption scams that resulted in reversing many licenses, foreign investors’ confidence and the credibility of the government had been completely eroded. The reality is that without massively increased foreign and domestic investment, both FDI and FII over the next 5-10 years, India will be flirting with another severe economic crisis given trends in our current account and aggregate fiscal deficits. Without such investment growth will remain below 6 per cent. The fragile dynamics of our twin deficits will spiral out of control leading to a debt crisis which will trigger a financial crisis leading to a broader economic crisis.

RBI and the government are working on giving new banking licences. Does that make sense? 

No it does not. The problem in India is not that we do not have a sufficient number of banks. It is that 70 per cent of our banking system is state-owned, inefficient, un-inclusive, and provides the means by which too cosy a nexus between the government and the wrong kind of private industrialists. The state-owned banks (SOBs) and insurance companies (SOIs) together provide the institutional mechanism to foster a dangerous and damaging type of crony capitalism regime in India as well as to indulge in electorally driven loan melas  and loan write-offs. . That unfortunate nexus is decidedly kleptocratic in nature when it comes to looting the nation’s natural resources (whether spectrum or mineral or land) through the kind of public-private partnership that India does not need. Moreover the Indian fiscus cannot afford to keep meeting the capital needs of the state-owned banks. And the SOBs certainly do not serve the interests of the poor or the disenfranchised

But don’t we need more banks?

Creating new private banks to compete for 30 per cent of the banking pie does not seem to me the answer to the problem of making the banking system more capable, responsible, efficient and inclusive. The answer lies in privatizing the SOBs and SOIs and in giving far more room to foreign banks to enter and serve the Indian market without the extreme restrictions that the RBI imposes on them. Many people will look to the 2008 crisis and say that is exactly the wrong solution for India. They would be wrong and would be looking at the wrong lessons to learn.  I worry that many of the new licenses will be given to unfit and improper persons that are politically well-connected rather than potential bankers of judgment and probity. Look at the line up (of those interested in opening banks) and you would need to worry about the “fit and proper test”.

What about giving licenses to industrialist to open new banks?

I do not think large industrial houses should be allowed to run banks. There will be massive scope for malfeasance. It is only in Japan and Korea that industry/trading houses (zaibatsus and chaebols) have got banks under their vast and diversified umbrellas. Japan is still struggling with the two decade old financial crisis. It is when ownership of banks is distinct from that of industry, media  and services that the economic and financial systems work best.

 In India, there is a huge hue and cry for financial inclusion? Is that a good thing?

That is partly so since state-owned banks are so dysfunctional and they do not work. All this euphemistic talk of expanding financial inclusion in India terrifies me. It is one factor which led to the global financial crisis in 2007-08 when Greenspan thought that the idiotic things that US banks were doing – by lending Mexican gardeners multiple mortgages at 130% of home value and classifying these loans as being made to ‘landscape architects’ --  were great in the name of financial inclusion. Mexican gardeners were being included in the wealth chain of California, Arizona, Colorado and New Mexico. Now we can all see what that led to.

It is not as if we have not tried inclusion before in India. Only then we called it agricultural and rural credit. The banking system has taken massive repeated losses with that type of lending.  That has also been the experience of most developing countries around the world. That is not because farmers and rural dwellers are fundamentally untrustworthy. It is because they are poor and exposed to risks they cannot manage.

What we need instead of issuing new banking licenses is a clear strategy on how the government exits from state-owned banks. The other institution that I have become very worried about is the Life Insurance Corporation of India (LIC). It is has become the largest institutional investor in the Indian economy and it functions in a manner that is not entirely publicly accountable, transparent or clear. Its investment decisions and their timing are a mystery to me and most others. Sometimes they seem to be driven more by political rather than fundamentally economic or cyclical decisions. 

You must have seen in most of the disinvestment program, LIC becomes an unofficial underwriter for the government? 

It is not a disinvestment program. It is simply moving assets of from one side of government ownership to another side. The camouflage fools no one. In my view it is time to end all this nonsensical babble about disinvestment for reasons of political correctness. India does not need to proceed with creeping disinvestment. To secure its economic future it needs to proceed on a large scale with sensibly planned and phased privatization.

No one is asking questions to LIC? 

In that context I think that the IRDA Chairman was absolutely right in opposing lifting the investment ceiling for LIC from 10% to 30% in any single enterprise and the MoF was entirely wrong to ignore his advice and force the issue for the sake of expediency.

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