Keep businesses away from private banks


Through Seela Subba Rao

Recently, former SBI Chairman Rajnish Kumar felt that in a country like India, allowing companies to own banks comes with great risk. He advocated for banks to be properly owned and professionally managed. Similar views were echoed by former RBI Governor Raghuram Rajan as well as former RBI Deputy Governor Viral Acharya.

On June 20, 2020, a five-member Internal Working Group (IWG) was formed by the Reserve Bank of India to review the existing ownership guidelines and corporate structure of Indian private sector banks. The IWG had two members of the RBI Central Council and three RBI officials. He submitted his report including 33 recommendations in November 2020 to the central bank to allow large companies to become bank promoters.

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Recommendations

On November 26, 2021, the RBI reportedly accepted 21 of the 33 recommendations and the others, including a controversial suggestion to allow companies to operate private banks, were “under review.” The RBI accepted the recommendation to allow the limit on 15-year long-term promoters’ holdings to be raised to 26% from the current 15%, providing relief to private sector banks such as Kotak Mahindra Bank, IndusInd Bank, Bandhan Bank and CSB Bank. He also accepted the proposal to keep the participation of non-promoters capped at 10% for individuals or non-financial institutions.

The ceiling will be 15% for all categories of financial institutions, supranational institutions, public sector enterprises or government entities. However, the central bank clarified that existing instructions on the RBI’s pre-approval requirement to acquire a stake or voting rights of 5% or more will be maintained.

The regulator accepted the proposal which authorized an increase in the minimum initial capital required for the approval of new banks. He also accepted the proposal to toughen the rules controlling the huge NBFCs by making them as strict as banking laws. Payment banks must operate for at least five years before applying to become small finance banks, going against the recommendation of the three-year working group. The central bank also doubled the initial released share capital / equity required to set up a new universal bank, to Rs 1,000 crore from Rs 500 crore now.

Private companies can only be allowed to promote banks after the necessary changes to the Banking Regulation Act 1949. This would allow the central bank to have the power to exercise consolidated supervision over conglomerates, i.e. financial and non-financial entities. Industry circles speculate that Bajaj Finserv, L&T Finance, Piramal and others may be some of the large companies still interested in obtaining banking licenses.

Some apprehensions

Allowing businesses to own banks has both advantages and disadvantages. The main advantage is that it will allow promoters to inject more funds / capital which is essential for the growth of banks and to function as a cushion in the event of a cyclical downturn. The downside is that corporate owned banks would commit to providing related loans to their entities / equipment which would lead to excessive concentration. Therefore, allowing companies to own private sector banks remains a billion dollar issue.

It is a well-known fact that if a bank lends too much to one company, it risks losing that money if the company goes down. With this in mind, a set of new guidelines, i.e. the single exposure standards cap, were issued by the RBI in 2016 on limiting lending to a single company. It is also recognized that banking regulators / supervisors in India are not strong enough to prevent connected lending and therefore the decision to involve private actors was not without risk. The recent failures of private banks like Yes Bank are a glaring example. Mixing the houses of industry and finance will put us on a dangerous path, which will push us into the era of pre-nationalization, that is to say before 1969.

Due diligence

Banks owned by large industrial companies have resulted in a high concentration of resources in the hands of a few business families. To verify this, the dispensation / government of the time had recourse to the nationalization of banks in 1969 (14 banks) and again in 1980 (6 banks). This resulted in a greater volume of credit flows to priority sectors. Without a doubt, it has proven to be an effective instrument for economic development and inclusive growth in the country. This trend, which has been established for so many years, must not be distorted.

According to the RBI guidelines published in August 2016, for the “on-the-fly” licensing of universal private sector banks, individuals and companies directly or indirectly linked to large industrial companies are allowed to participate in the capital of the private sector. ‘a new private sector bank up to a limit of 10%. This arrangement seems reasonable to some extent as it should not have a controlling stake in the bank. Exceeding this limit can be tantamount to sounding the alarm.

The strengthening of the supervisory mechanisms within the banking regulators / supervisors of the large conglomerates is the need of the moment. To prevent loans and related exposures between banks and other financial and non-financial entities, consolidated supervision should be undertaken periodically and diligently. To facilitate this, the necessary amendments to the Banking Regulation Act 1949 can be adopted at the earliest.

It is relevant to mention here that the cardinal principle that new banks proposed in the private sector must maintain an arm’s length relationship with the business entities of the promoter group and the individual company (s) must be followed in the letter and the spirit at all costs.
In view of the cases of violation of exposure standards, deviations from the regulations of the Foreign Exchange Management Act (FEMA), the occurrence of high NPAs and other irregularities revealed in some private banks, it is necessary to be more careful when licensing new banks.

(The author is the former Deputy Managing Director, Nabard)

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