Allowing Banks for Business Houses by RBI: Is this the Right Move?

Reasons and criticisms on allowing Banks for Business Houses by RBI: The recent big news hit the market when RBI Internal Working Group’s suggested that large corporates and conglomerates could own banks. They believe that big business houses can be an important source of capital along with bringing in their experience, expertise, and strategic management to banking.

In today’s Market forensics by Trade Brains, we’ll be discussing this news allowing banks for business houses as per RBI recommendation. Let’s get started.

What is RBI and Why is it in News?

Let’s first start by defining what is RBI. Simply, RBI is an acronym for Reserve Bank of India and it is responsible for the issue and supply of the currency. RBI is also responsible for the regulation of the Indian Banking System. Its function also includes aiding Government in the overall economic development. RBI commenced its operations on 1^st April 1935 in accordance with the RBI act of 1934. And post-Independence in the year 1947, RBI was nationalized on 1^st January 1949.

The Internal working group (IWG) constituted by RBI on June 12 to review “extant” ownership guidelines and corporate structure of Indian private sector banks, submitted its report on November 20 (Friday). The following were its suggestions:

• A well run Non-Banking Financial Companies (NBFC’s) with assets of Rs. 50,000 crores or more, and operations of 10 years or more could be converted into Banks. Companies like Shriram Capital, Aditya Birla Capital, etc are the prominent players in the Indian NBFC eco-system.
• Payments banks can be converted into small finance banks (SFC’s) after being in business for three years. Small Finance Banks and Payments banks can be listed within 6 years from the date of reaching net worth which is equivalent to entry capital requirements for universal banks or 10 years from the date of commencement of operations, whichever is earlier.
• For Universal banks, the minimum capital requirements to be enhanced to Rs. 1,000 crores from Rs. 500 crores earlier. And from SFB’s the minimum capital requirements to be increased to Rs. 300 crores.
• The group has also recommended that large Industrial houses can also be converted into banks only after necessary amendments to the Banking Regulation Act, 1949.
• RBI may take steps to ensure harmonization and uniformity in different licensing guidelines, to the extent possible.

Corporates as banks: Why is RBI recommending it?

Now, let us try and understand why did the IWC recommend allowing business houses to be entered into the business of banking.

• A strong and robust banking system is the backbone of any economic system. And to promote the wider availability of credit and to prevent the misuse of capital, the government of India nationalized the banks first in 1969 (14 banks) and further in 1980 (6 banks). And post nationalization, private banks entered the foray and it did have a statutory impact on the credit growth (Image 1). But the growth of credit has been much lower and slower than what was actually expected. Even after three decades of constant growth, the balance sheet of Banks constitutes only 70% of the Indian GDP, which is very less when compared to other countries like China (170% of GDP), Japan, and other European banks.
• Even the domestic bank credit to the private sector is very less. Only 50% of the GDP (Image 2), which is very less when compared to other major economies like China, Japan, Korea (most of them upwards of 150% of GDP).
• Clearly, it is time that India needs to bolster its credit system if they have to attain global supremacy. And as seen from Image 3, it can be seen that the Public sector Banks have been losing ground to Private sector banks in terms of deposits and credit lending. And this can also be mainly attributed to the mismanagement by the public sector banks and beleaguered balance sheets on account of Non-performing assets (NPA’s)

From the above discussion, it will be safe to say, increasing the share of private banks has bought about the much-required robustness in the Indian Banking system. And further increasing their participation in the banking system could mean only one thing, more robust and fast-paced growth. So, it is safe to say that there is space for both Public and Private sector banks, for the evolution and growth of the Indian banking system.

Image 1: Banks assets as a Percentage of GDP (source: RBI)

Image 2: Domestic bank credit to the private sector (source: RBI)

Image 3: Public Sector Vs Private Sector Banks (source: RBI)

Why is this new proposal of RBI being criticized?

In a joint write-up, former RBI Governor Raghuram Rajan and former RBI deputy Governor Vishal Acharya have severely criticized the new recommendation from RBI. They went on to describe it as a “bombshell”. They expressed their view by calling it shortsightedness and also expressed their concerns regarding the governance if private players were allowed to operate banks.

Historically, RBI has been of the view that the ideal banking system should promote a balance between efficiency, equity, and financial stability. And in the past, even for private banks, the regulators have preferred diversified ownership i.e., no single owner has too much stake.

Moreover, the main concern with the business house having a total business of more than rupees 5000 crores or more, where the non-financial business of the group accounts for more than 40% of the total assets or gross income – to  have a business of banking is a conflict of interest and technically, “Connected Lending”

What is Connected Lending?

In simple terms, it is a situation whereby the promoter of the banker is also the borrower from the bank. And in that condition, it is possible for the promoter to channel the money of the depositors into funding their own ventures. And which is always a risky proposition.

In the past, RBI is always been against the suggestion of private players being allowed to open banks. And even the IWG committee also met with stern opposition while proposing this policy from experts. All the experts were of the view that business houses and private players should not be allowed to promote banks.

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Closing Thoughts

If you are yet looking for why is Banks for Business Houses move recommended by IWG, the simple reason is that the Indian economy especially the private sector is in need of money. The Public sector banks are struggling with their issues of NPA’s.  It will be easier for large corporates to fund credit in the system as they come with deep pockets. But this comes with its own sets of risks and challenges. Only time will tell, the effectiveness of private players to provide the much-needed impetus to the Indian Banking system

That’s all for today’s Market Forensics. We’ll be back tomorrow with another interesting market news and analysis. Till then, Take care and Happy investing!!