Best left in the shelf

One, I have been writing this column for 10 months and the simple truth that this is my fourth column on India's banking sector is a telling marker. Two, I like to write different, but this is the first time in 10 months that I am writing back-to-back columns on the same subject (banking, in this case); that makes things a mite more vivid. Three, all four columns have carried bad news – that's because, well, because there's nothing good to share. And four, the above three pointers mean we are reaching a crunch-point. What's a crunch-point, you ask? Well, that's generally the point where our financial planning goes rancid and our sensitive body parts hurt; hurt real bad.

Last week, the Reserve Bank of India's (RBI) Internal Working Group (IWG) made recommendations that the country's industrial houses be allowed to float and run banks. What does that mean? Well, it basically implies that you and I have to open a company with large enough capital, regardless of our backing, background, expertise and knowledge, and then launch our very own bank. And when we have that very own bank, we can seek deposits, offer incentives to account-holders and investors, hire staff, set up branches and ATMs. And of course, since you and I are now valid bankers, we will use our depositors' funds to extend loans and become official money-lenders, of sorts. And hurrah, there's really nothing stopping us from extending those loans to family and friends, or to ourselves.

That is the crunch-point referred to above, where the hurt and pain begins to manifest and be felt.

Instant mortification

I am not the only one mortified and wounded here; some very learned people have taken up cudgels over the IWG's recent recommendation, bluntly expressed their outrage and consternation. To begin with, we have former RBI Governor Raghuram Rajan and Deputy Governor Viral Acharya, who have openly spoken out against the proposal to allow industrial houses to run banks. "Why now? Have we learnt something that allows us to override all prior caution on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking," Rajan and Acharya said in a joint statement, released on the former RBI Governor's LinkedIn handle.

According to the two, granting official licenses to industrial houses will concentrate economic powers to the concerned Corporates. When the industrial houses need financing, they will easily get that, no questions asked, from banks floated by (you guessed it) themselves. Banks in India are rarely allowed to fail, which helps them garner huge deposits. If they are owned by industrial houses, it can lead to bad lending, Rajan and Acharya thundered, in a now rare-in-India show of open dissent. They also left their posts in dissent.

"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 (sic) 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 duo said.

Tough to regulate

Regulators anyway have a tough task ahead of them in terms of monitoring banking activities, especially loan disbursals and NPA (non-performing assets) realities. Political and other pressures strongly resonate in the Indian banking sector, making it tough to follow up with high-profile borrowers, particularly when they turn into defaulters – remember Vijay Mallya, Nirav Modi, Mehul Choksi, the first two now residing in London and the third in Antigua and Barbados isles?

Also, the tight regulations around group lending norms introduced in 2016 have since been relaxed, Rajan and Acharya point out, making it difficult to figure out if any new borrowing company 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," he wrote. A burning rationale on why industrial houses should not be considered for a banking license is that this will concentrate economic and political powers with a few chosen business houses, which will provide them (with) an unfair advantage, since they will be the few that will have the initial capital needed to set up a new bank.

"Highly indebted and politically-connected business houses will have the greatest incentive and ability to push for (banking) 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 two 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."

Yet it recommends change?

Why is there this 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? Interestingly, Rajan and Acharya also refer to the IWG report's appendix, which points out that all the experts consulted, except one, were against allowing industrial houses to float banks. "Yet it recommends change," the two exclaim.

Clearly, there are forces at play here. Sure, India needs more banks and credit penetration, and the RBI's approach in allowing firms that are mostly into financial services into the banking space is the right one. The central bank has allowed industrial houses to come up with payments banks. These banks can tie up with other banks for retail lending. But why, indeed, does India need industrial houses to get full-fledged bank licenses? Most important, why now, at a time when we are still trying to learn the lessons from failures like ILFS and Yes Bank (and Lakshmi Vilas Bank)? It is indeed penny wise and pound foolish to replace the poor governance under the present structure of these banks with a highly conflicted structure of ownership by industrial houses.

So who am I, a retired Corporate professional and a temporary hack, to question experts? To my credit, I am a valid Indian citizen and a bank account-holder, with my own rights. Personally, I find IWG's recommendation disconcerting, especially those that intend to reduce the time-frame of converting a payments bank into a full-fledged commercial bank from five years to three years. Changing regulations to try and ensure that large Corporates turn into responsible bankers is not feasible or sensible. The same regulations did nothing to stop established banks from accumulating huge bad debt on their balance sheets, NPAs that are slowly bringing Indian banking to its knees.

Others are crying foul too

It is not just Rajan and Acharya (and me!) crying foul. We have agencies like S&P Global Ratings also expressing skepticism over RBI allowing corporate ownership in banks, "given India's weak corporate governance record amid large corporate defaults over the past few years".

"In our view, the (IWG's) concerns regarding conflict of interest, concentration of economic power and financial stability in allowing Corporates to own banks are potential risks. Corporate ownership of banks raises the risk of inter-group lending, diversion of funds and reputational exposure. Also, the risk of contagion from corporate defaults to the financial sector increases significantly," S&P said. S&P also contended that NBFCs becoming banks could improve financial stability, even as it warned that the RBI would face challenges in supervising non-financial sector entities and that resources could be "further strained at a time when the health of India's financial sector is weak".

Admittedly, NBFCs have strengths that may give them a head-start in their entry into banking – such as an existing client base, distribution network, brand and risk management systems. Conversion to a banking entity could provide stable funding, and in particular low-cost deposits. Sure, the competitive banking environment in India will likely not deteriorate with these new licenses, more so as finance companies converting into banks will have large upfront regulatory costs, such as cash reserve ratio and statutory liquidity ratio requirements, priority sector lending and adjusting their existing portfolios to reduce concentration in one segment.

My end-of-day musing? Well, we in India seem to like to play with fire… But juggling it nonchalantly is worrisome. The proposal to allow India's industrial houses to launch and operate banks is akin to pulling the pin out of a grenade and gleefully waiting for it to go ka-boom. The question is how many of us will go boom along with it? Have we already forgotten Punjab and Maharashtra Cooperative Bank, YES Bank and Lakshmi Vilas Bank? Or worse, have we learnt to live with them happening repeatedly?

The writer is Consulting Editor and clinical analyst. narayanrajeev2006@gmail.com