Stable banking

Mixing financial and industrial power should be avoided

The Reserve Bank of India (RBI) has done well not to open up the banking sector for industrial houses, at least for now. The RBI had set up an internal working group in June 2020 to examine the ownership guidelines and corporate structure in private sector banks. The group, which submitted its report later in the year, had recommended that industrial houses be permitted to promote banks after necessary amendments to the Banking Regulation Act, 1949. The group also argued there were very few countries that explicitly prohibited industrial houses from setting up banks. The RBI last week announced it had accepted 21 of the 33 recommendations of the group, and the others were under consideration.

There is no dispute that India needs more banks to cater to the diverse needs of both businesses and consumers. More competition in the banking sector will increase innovation and help improve the flow of credit. Besides, the Indian banking sector is dominated by state-owned banks, which as a group are not in a position to cater to the needs of the Indian economy because of a variety of issues, including recurrent asset quality problems. Thus, more banks in the private sector would be useful. However, opening the door for industrial houses to set up banks is not the answer. In fact, this could create more risks in the system.

Unsurprisingly, the suggestion to permit industrial houses to set up banks was opposed by experts, including former RBI governors and chief economic advisors to the government of India. In a November 2020 article, economists Shankar Acharya, Vijay Kelkar, and Arvind Subramanian, for instance, concluded, “... mixing industry and finance will set us on a road full of dangers — for growth, public finances, and the future of the country itself. We sincerely urge policymakers not to take this path.” The possibility of collusion between financial and industrial capital in India should be avoided. Aside from the issue of connected lending, which could lead to higher systemic risks, this will enable the concentration of power. It is also worth recognising that India has fairly limited regulatory capability to contain both the concentration of market power and risks. Thus, the RBI would be well advised to avoid taking this path.
 

Among other recommendations, the RBI has accepted the proposal for allowing the promoter holding cap to be raised to 26 per cent of the paid-up voting equity capital in banks. This will help maintain the balance. While the shareholding will be adequately diversified, promoters will be in a position to bring in more capital if required. The RBI has also accepted the recommendation of subjecting large non-bank financial companies (NBFCs) to tighter, bank-like regulation. This is critical as some of the NBFCs have gained significant size and are systemically important. The minimum capital requirement for setting up banks has also been increased. The capital needed to set up a universal bank, for example, has been increased from Rs 500 crore to Rs 1,000 crore. A higher level of capital will certainly make the bank more stable. But since the idea is to have more private sector banks, higher capital requirements can perhaps be imposed with the expansion of the balance sheet over time. Nonetheless, the changes accepted by the RBI are broadly in the right direction.

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