“The history of such connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending. Information on loan performance is rarely timely or accurate. Yes Bank managed to conceal its weak exposures for considerable periods,” the authors said.
Regulators can also succumb to political pressure of the urgency of the moment. The tight regulations around group lending norms introduced in 2016, have been relaxed recently, the former central bankers wrote. It is also difficult to distinguish if a borrowing entity is part of a group entity.
“Some favoured ones are expanding merrily, financing assets purchases with yet more borrowing, imposing greater risks on the system,” they wrote.
Another crucial reason why industrial houses should not be entertained is a banking license will concentrate the economic and political powers with certain business houses. It will give undue advantage to large business houses that already have the initial capital that has to be put up.
“Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses. That will increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism,” the duo noted.
The regulator can distinguish between “fit and proper” businesses and shady ones, but for that, “it has to be truly independent, with a thoroughly apolitical board. Whether these conditions will always prevail is debatable.” Besides, after getting the license, the licensee would likely want to misuse it with an intention to self-lend. The entities will start with a big bank, but if the banks fail, the cost to the exchequer would be significantly larger than for banks floated by others.
“Why is there urgency to change the regulation? After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?” The duo pointed out the report’s appendix where it pointed out that all the experts it consulted except one were against allowing industrial houses from floating banks. “Yet it recommends change!” the authors expressed surprise.
Even as India needs more banks and credit penetration, the former top central bankers argued that RBI’s approach in allowing firms that are mostly into financial services is the right one, as it brings management efficiency. The central bank has allowed industrial houses to come up with payments banks. These banks can tie up with other banks for retail lending. “Why again do we need industrial houses to get full-fledged bank licenses? More importantly, why now, at a time when we are still trying to learn the lessons from failures like ILFS and Yes Bank?”
It would also be a mistake to sell public sector banks to industrial houses, instead, far better would be to professionalise public sector bank governance, and sell stakes to the broader public.
“It would be ‘penny wise pound foolish’ to replace the poor governance under the present structure of these banks with a highly conflicted structure of ownership by industrial houses.”
The duo also expressed surprise at the recommendation of the IWG in reducing the timeframe of converting a payments bank into a full-fledged commercial bank from five years to three years.
It won’t be enough to give licenses to industrial houses by just changing the regulations. Regulations could not stop huge bad debt accumulation in banks.
“It is hard not to see these proposed amendments as a subtle way for the IWG to undercut a recommendation it may have little power over," Rajan and Acharya said, adding, while many of the technical points of the IWG recommendations are worth adopting, giving licenses to industrial houses is an idea “best left on the shelf.”
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