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With the Reserve Bank of India (RBI) poised to issue new banking licences, there has been much debate over the criteria for awarding these licences, in particular whether large industrial houses should be eligible, and, if so, what conditions should apply.
The context in which these debates occur is a financial sector in which the non-banking sector (or “shadow banking”) has grown enormously and regulatory complexity has increased manifold. In banking itself, however, public sector banks continue to play a dominant role, while the regulator (the RBI) continues to have a latent conflict of interest — the regulator periodically presses banks to help the government in meeting its borrowing requirements and exercises considerable caution when banks lend to politically connected firms.
The biggest concern over granting large industrial houses bank licences is the risk of conflicts of interest and self-dealing, resulting in banks promoted by large industrial houses giving preferential access to credit – and greater forbearance – to other companies linked to their promoters. One might recall that this was a key rationale of bank nationalisation in 1969.
The other side of the argument is that only large industrial houses have the deep pockets to set up large banks that can reap economies of scale, and potential conflict of interest issues can be managed with a strong regulatory framework. And since, in any case, large industrial houses are already involved in the non-banking financial sector, why make a fuss about bank licences?
That the public sector-dominated banking sector is severely underperforming is not particularly contentious. In principle, there could be much greater competition if some of them were privatised. This strategy is a non-starter, since the state does not want to loosen its grip despite their low profitability and the need for the government to periodically pump money into them to cover their losses. Another option to revitalise banking would be for the government to give up its majority stakes in even a few public sector banks, with adequate representation from the government to ensure that their governance is aligned with the public interest. But that too is unlikely for reasons noted below. Meanwhile, because of the “government overhang”, a price discount on public sector banks remains.
Hence, if banking is to be revitalised, the case for having more new banks, and especially more private-sector banks, is abundantly clear. But does India need many more small banks – some of which will grow rapidly, some less and some will die – rather than a few large banks promoted by large industrial houses? An understanding of the current relationship between Indian banks and large industrial houses might be helpful in this regard.
Between 2006-07 and 2011-12, Indian banks’ loans grew by more than 20 per cent annually. According to a report by Credit Suisse (“House of Debt”), during this period aggregate debt of just 10 industrial houses jumped fivefold to nearly $100 billion, accounting for 13 per cent of bank loans (from just under six per cent in 2006-07) and 98 per cent of the banking system’s net worth. India is an outlier in the degree of concentration of the banking sector’s assets, more than double that of chaebol-dominated South Korea and hugely greater than China (one per cent). Only Russia comes close: 11 per cent. It is, of course, entirely possible that the doubling of bank loans to firms in what Michael Walton has called “regulatory-intensive sectors” in the years when crony capitalism in India has been most manifest is just a random coincidence.
These groups – each of which accounts for one or two per cent of total banking system loans – are mainly in power, construction/real estate and metals/mining. According to the RBI, in 2010-11 there were 49 cases of corporate debt restructuring involving Rs 22,620 crore, 87 cases involving Rs 67,890 crore during 2011-12, and 59 cases involving Rs 30,640 crore during April-August 2012. If Kingfisher Airlines is any example, banks appear to have considerable latitude in regulatory forbearance on asset classification, especially if the group is politically connected.
A different way to look at the concentration of outstanding credit of the Indian banking system is credit size. RBI data for 2011 indicate that 95 per cent of all accounts that had taken credit from scheduled banks held loans of Rs 5 lakh or less but amounted to 16.8 per cent of outstanding bank credit. At the other end, loans of Rs 25 crore and above amounted to just 0.23 per cent of all accounts, but a full 47 per cent of outstanding bank credit. And in case you did not guess it, in the case of public sector banks, loans above Rs 25 crore account for more than half (51 per cent) of loans outstanding, compared to 37 per cent for private banks — undoubtedly fulfilling the rationale of the Bank Nationalisation Act of 1969, to ensure that banking was “inspired by a larger social purpose”.
There are many lessons of the 2008 financial crisis, but the most relevant one in this case is that no matter what the regulatory regime, when profits are large and private while the downside risks are public, virtue will always lose if there is a conflict between profits and virtue.
In considering whether to give out bank licences to large business houses, we should have few illusions on the current state of India’s political economy — today, a seemingly minor discretionary appointment like the officer on special duty to finance minister can wreak havoc. Yes, in principle, firewalls can be created between corporate interests and banking/financial interests; in reality, these arguments are simply bromides. The risks surrounding the conflict of interest in the current Indian institutional context outweigh any possible gains from economies of scale. Kingfisher and Sahara offer object lessons on regulatory forbearance and the difficulties of ensuring that judicial orders are actually enforced in a timely manner in the case of connected firms. And these are not even the largest players.
Instead of large corporate houses, there is considerable scope for the RBI to give out new bank licences to microfinance institutions and non-bank financial companies with a strong track record, and to financial sector professionals with the capital to start a bank. If the political pressures on the RBI to give licences to companies are insurmountable, then it should at least insist on two simple rules: mandate a low ceiling on a company’s loans outstanding to the banking system to be eligible for a bank licence. For instance, the incentive structure for a company that has more than Rs 1,000 crore outstanding to the banking system is, shall we say, complex. Second, in case a bank owned by a corporate does go under, the entire assets of the company, and not just the capital invested in the bank, should be on call — rather than citizens’ taxes.
There is a real need for a fundamental shift in the financial food chain where the large carnivores – the government and large firms – have to shift to different grazing grounds, as their predatory behaviour is simply eating into the food for the aam aadmi equivalent of firms, namely small and medium enterprises, which are the critical drivers of employment and economic growth. This requires that large companies be nudged to raise a greater part of their capital requirements directly from capital markets while the government curb its fiscal deficits and reduce its claims on fiat bank credit. That, of course, is an even taller order.
The writer is director of the Centre for the Advanced Study of India at the University of Pennsylvania
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
