Raghuram Rajan against corporate houses in banking

At a time when the Reserve Bank of India (RBI) is considering whether to allow business houses to enter the banking business, renowned economist Raghuram Rajan has opposed the idea.

“I thought the old RBI policy of not allowing the corporates was a good one and I stand by that,” said Rajan, a professor at the University of Chicago and former chief economist at the International Monetary Fund. This was on the sidelines of a lecture delivered on the occasion of the 100th birth anniversary of the late H T Parekh, credited as the pioneer of the housing mortgage market in India.

The Reserve Bank of India (RBI) is in the final stages of preparing draft guidelines for the entry of private sector players in banking, and is considering to allow corporate houses. Till now, RBI has had a conservative policy on granting banking licences and did not allow large industrial houses. However, individual companies, directly or indirectly connected with large industrial houses, were permitted to own 10 per cent of the equity of a bank, but without any controlling interest.

“My personal view is that there is a sufficient amount of competition in the financial sector. What we need is innovative, new approaches,” Rajan said.

In a discussion paper on entry of new banks released by RBI in August last year, the regulator had argued that a larger number of banks would foster greater competition, reduce costs and improve the quality of service, apart from promoting financial inclusion. The paper explored pros and cons of allowing industry houses, non-banking finance companies (NBFCs) and micro-finance institutions (MFIs) in the banking sector.

In case corporate houses are allowed, there should be stringent conditions, said Rajan. “You have to (then) ensure there is no inter-company lending, they have proper risk management processes and they have sufficient transparency. That is why I would say, (RBI should) monitor them very closely, especially very early on, and even suggesting that their growth must not be too fast, unless there is confidence in their risk management processes. Otherwise, you could have problems,” he said.

Rajan, however, favoured banking licences to both NBFCs and MFIs. “I would think the first order in increasing competition is to give some of these people licences, rather than bring corporates into the process,” he said.

MFIs
On the MFI sector and the various new regulations sought to be applied to it, he said the government needed to be careful. The measures sought to be taken should not become detrimental for the sector as a whole.

“This is one of those situations where there are a lot of allegations in the practices of the MFI sector. What we should be careful about is that the cure should not be worse than the disease,” he said.

He added that once an interest rate cap is put in place, the regulator should effectively monitor the one charged by MFIs and make sure there were no hidden charges in the name of some fees.

Rajan also said the country needed to ease supply-side bottlenecks to tackle inflation. “We should be focusing on expanding the capabilities of the economy. Part of the inflation is because we are running against bottlenecks. The focus should be on infrastructure developments, financial sector reforms and education,” he said.

While expressing confidence on the growth of the economy, he said there may be ‘hicupps’. “We had the rebound from recession both in the industrial world and the emerging markets. Now it is showing more stable growth. I think in the medium term, there is no doubt on the India growth story. Will be hiccups along the way? I think that is possible.”