An urgent reform agenda for RBI

The nature of geo-politics and the rapid advances in digitisation require the Reserve Bank of India (RBI) to urgently rethink its extant supervisory policies. The ability of powerful nations to impose crippling blows on other countries without using conventional weapons of war is not fully appreciated. Bank regulations require to adapt to this new reality as financial systems are the core to an economy’s smooth functioning. The new issues that require a clear strategy include alleviating the impact of possible sanctions on local entities that are largely owned by foreign entities, data localisation, and defence against cyber-attacks by sovereign states. This is not all. It is important also to consider the implications of bank regulators choking fintech innovation and the accompanying customer welfare loss in the name of financial stability.  

The nature of geo-politics has undergone tremendous change with muscular policies on display by both the US and China. There is a clear erosion in the consensus on multi-lateralism.  The two new superpowers — the US and China — are trying in their own way to shape a world that provides them advantage and a leading position to be able to impose their own standards on the rest of the world.  India needs to be ready to operate in a world where global standards give way to unilateral shifts on issues that do not suit either superpower — either by revocation of multiple trade deals, the use of sanctions and extradition or a muscular and threatening approach in South China Sea or One Belt One Road (OBOR) initiatives in pursuit of domination.  President Trump was openly supportive of Brexit, and is critical of the EU, as it gives the US much greater bargaining leverage to negotiate against individual European countries, rather than Europe as a block.   

In this backdrop it is critical to examine the need for diversified ownership of banks. While a promoter cannot hold more than 15 per cent stake in a bank, foreign entities as a block can own 74 per cent without any concentration limit by a single country. Our largest private banks ICICI, HDFC and Axis all have majority foreign ownership.  In case, say the US, imposed sanctions, what impact would it have on the capital of our banking system? We need to carefully consider whether single country actions can cripple our financial system.  

Illustration by Binay Sinha
Much of the discussion around data today is in respect to privacy and usage and not geo-politics.  Here the RBI has acted decisively by issuing a circular in April 2018 to ensure that Indian data is stored in India to avert the risk of sanctions. The General Data Protection Regulation (GDPR) from Europe was a good wake-up call. The US is just starting to deal with the big tech companies and their indiscretions and there is always suspicion around the ability of the Chinese State to access data with its private tech companies. But India must store its data locally. 

The third area that requires a coordinated defence strategy is protection against a sovereign led cyber-attack on our banking system. Stress testing should check for cyber defence as much as bank credit portfolios. It is believed that five nations have advanced capability to impose heavy damage on others through their cyber-attack capability — the US, China, Russia, Israel and Iran.  It is both ironic and sad that despite all our IT capabilities we have not created a similar cyber capability. We need to think about this in the same way as nuclear deterrence.  

The other key trend — digitisation and machine learning (that data now allows) — has not been explicitly encouraged.  It has the potential to greatly enhance consumer welfare. Full financial inclusion will be spurred greatly by a full use of data which would over time potentially obviate the need for collateral. It is worth noting that the Bank of England has changed its bank licensing norms, and since 2013 has issued 15 new bank licences. Currently, we have a licensing regime where it is relatively easy to get a Non-Bank Finance Company (NBFC) licence, possible to get a payments bank licence or small bank licence, but next to impossible to get a full bank licence.  As a result we have over 12000 NBFCs but only 25 of them have about 85 per cent of the total NBFC assets outstanding.  Some are bigger than banks.  NBFC licensing should spur fintech innovation, yet the collapse of IL&FS proves that the RBI should regularly convert the largest NBFCs, over a certain threshold, into banks so that they face stricter regulatory regime and their ALM mismatches do not create any systemic risk. The payments bank business proposition without lending is hardly viable and the history of small banks in India has not been good.  Thus, I argue that there should be a regular conversion of large NBFCs into banks and easy entry into the financial sector as NBFCs to spur innovation. The recent RBI regulations on co-origination of assets with NBFCs is a step in the right direction to spur fintech innovation at least in priority sector. But the RBI must ease the bank licensing regime to allow challengers to spur innovation. 

An allied issue that the RBI should seriously consider is the false belief that diversified ownership of banks is superior to allowing for a dominant shareholder with substantial ownership.  The global financial crisis arose in a banking system with diversified ownership.  A dominant shareholder may have provided sharper oversight on the bank management.  I believe it is important to revisit the 15 per cent maximum limit in India to, say, 26 per cent urgently. Further simple hygiene requires a clear articulation of capital holding norms by a shareholder and how it is to be calculated.  

Further, the hesitation to allow industrial houses bank licences is perplexing.  Some of our best NBFCs are owned by industrial houses.  It is easy to enforce restrictions on inter-group lending if there is a fear of resources being cornered by the banks for other group companies.  The case to deny industrial houses a bank licence should be made on the reputation of the industrial house, based on clear criterion rather than the weak logic situated in an earlier era. The RBI would do well to review its guidelines. 

RBI policies need to evolve to take cognizance of both the geo-political risks that exist in the world and the opportunities that machine learning and digitisation offer the world and most pointedly the financially excluded poor Indian. 
The writer is chairman - India, Boston Consulting Group. Views are personal



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