They have capital and managerial expertise but the issues of conflict of interest and inadequate regulation cannot be ignored
Chairman, India Infoline
“Industrial houses have a proven track record and an experienced team at the helm. Also, they have been permitted to operate in other financial services sectors like insurance”
The Reserve Bank of India (RBI) is expected to issue final guidelines for licensing private sector banks shortly. Whether the guidelines should allow industrial houses to promote a new bank is hotly debated. This needs to be first understood against the backdrop of how many new banks should be allowed licences.
Just as India needs many more roads, ports, factories and hospitals, it needs many more banks. Even today, 43 per cent of India’s population does not have a bank account. Besides, even among 57 per cent of Indians that supposedly have bank accounts, a large number of accounts are defunct. There are thousands of no-frills bank accounts opened under the financial inclusion drive that soon become inoperative. One expects to see financial inclusion of the masses — not just in letter but also in spirit. Financial inclusion should entitle the benefits of regular savings, including interest, credit access at reasonable rates, fund transfers, guidance and a platform to invest in financial products like government bonds, insurance, mutual funds, corporate bonds, equities and so on. New bank licensing should, therefore, have an open policy, without restrictions on number or time frame, so that there is no scramble, lobbying, pressure or rush to apply in limited window. That will ensure that new banks enter in an orderly manner in line with the economic expansion.
Now, let’s examine the issue of industrial houses. In 2001, RBI did not allow industrial groups to promote new banks. It allowed companies connected with industrial groups to own up to 10 per cent equity in banks. The July 2006 report of the high-level committee constituted by RBI recommended that the central bank should evolve policies to allow industrial houses, on a case-by-case basis, to have a stake in Indian banks or promote new banks. The report also suggested encouraging non-banking financial companies to convert into banks. An argument in favour of industrial houses is that they are typically well-capitalised and widely held. They have a proven track record and a vastly experienced team at the helm. Second, industrial groups have been permitted to operate in other financial services sectors like insurance.
In contrast, there are equally valid arguments opposing the entry of industrial houses in banking, such as concentration of economic power, conflict of interest undermining the independence of banks and difficulty in monitoring the flow of credit to its associates, customers or suppliers. Internationally, some countries allow industrial houses to own a bank with restrictions, whereas some do not allow this at all.
In India, given RBI’s deep understanding and a stellar track record in the development of the Indian banking sector, and extra ammunition provided by the Banking Amendment Bill, there is no need to restrict any particular group from promoting a bank — be it an industrial house or a capital market or a broking entity. The key requirement for any applicant should be commitment to raise a foolproof Chinese wall around the new bank activities.
Critics may argue that in India, there have been instances of RBI’s bad experience with certain industrial groups that had promoted banks. However, extrapolating some instances to the entire class is inappropriate. It is vital to have the right corporate structure and regulatory framework. RBI has already covered this in the draft guidelines by including additional considerations in respect of promoter groups having 40 per cent or more assets or income from non-financial business. The requirement is to have a majority of independent directors and to have the exposure of the bank to any entity in the promoter group capped at 10 per cent.
Given the primary objective of new banks is financial inclusion, giving new licences to industrial and non-industrial houses must come with conditions about new branches in very small cities and rural areas, and the commitment of a certain share of business from such under-banked areas.
Director, PricewaterhouseCoopers
“Unflinching institutional commitment and culture is scarce across the world and more so in India. Herein lies the real fear in giving bank licences to corporate houses”
The issue of granting bank licences to large corporate houses has put the Reserve Bank of India (RBI) in an unenviable “damned if you do, damned if you don’t” predicament. We would do well to remember that the context of this discussion is the post-2008 policy impetus to create a strong domestic (indigenous) banking system. In this context, then, RBI must choose the best applicants — those who will bring in domestic capital, set up technology-savvy banks with wide distribution networks for the financially excluded, subject themselves to open-ended regulatory oversight, generously divest ownership down to 15 per cent within 12 years and, most importantly, not look at the bank that they set up with greedy eyes to fund their group businesses.
Do such applicants exist? Apparently, plenty of them do — more than RBI can eliminate through entry barriers set out in the guidelines. On the other hand, there are formidable opinions, including those of C Rangarajan and Joseph Stiglitz, against granting bank licences to corporations owing to the conflict of interest inherent in the basic proposition. Indeed, there is something to be said for concentration of economic power and wealth in India.
Banking is a highly competitive business today and the conclusion in the Discussion Paper is unambiguous. “Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank,” it notes. It is very difficult to locate who would fit this bill outside of the corporate world and stand-alone financial houses, many of whom are proposed to be blocked out owing to exposure to broking and real estate businesses. With the voting rights amendment, there was perhaps an opportunity to use foreign banks in partnerships but that option has already been shut out. So, we are back to considering not the question of “whether” but the question of “how” to tackle this dilemma of domestic capital and smart business models versus conflict of interest and concentration.
The benefit of hindsight provided by the financial crisis affirms the Hobbesian conclusion that unwavering oversight is a necessity and no a priori assumptions should be made about any individual or group when it comes to trusting them with public money. Indeed, in the US, which is often cited as a virtuous jurisdiction for not giving bank licences to corporate houses, bankers found a way to plunder banks.
Good governance is a matter of values and unflinching institutional commitment. Admittedly, such commitment and culture is scarce across the world and more so in India, but it can be present in corporate groups as well as in others. Herein lies the real fear in giving bank licences to corporate houses. First, quantifying selection criteria that must necessarily be qualitative and then, ensuring that there is ongoing compliance. The concept of consolidated supervision is still new in India. The West was supposed to have developed an effective framework.
The financial crisis has exposed the chinks and shattered our confidence. If it is so complicated to regulate financial groups, how incredibly complicated will it be to regulate and supervise financial groups that are part of large corporate groups with their spaghetti web of entities, vendors, suppliers, related parties and domain of influence? One of the ways to tackle this is to ring fence the deposit institution from the rest through appropriate holding structure. At this point, we do not have enough clarity on how the ring fencing is proposed and what firewalls will be in place. On the other hand, the draft guidelines propose wide powers of consolidated oversight, which will be challenging to implement. If these issues are not sorted out upfront, both the regulators and the regulated group will find the aftermath of licensing to be painful.
These views are personal