Millennium Post

Too many banks spoil the credibility

Have you ever felt that there are too few banks around for meeting the banking requirements? Most people will not have. But policy makers, including the Reserve Bank of India, think otherwise. Hence, there is a move afoot to create more banks in India and a new banking licence policy will be announced by the central bank in a couple of weeks.

The issue of creating fresh banks has been discussed for sometime now. Last year, the central bank had made public a detailed discussion paper on various aspects of giving out new bank licences. The discussion paper was noted in these columns. It had evoked considerable response from those who are interested in setting up new banks as also the informed public. The finance ministry had also sent its comments to the RBI for formulating the final framework for allowing new banks. With such inputs, RBI is now supposed to reveal the final policy.

There still remain a few unresolved issues regarding granting of fresh licences for new banks. These are critical since a bank is not like any other business, where in case a business fails, only a limited number of people are affected. An industrial company can have major impact, in case of its failure, to its own employees and its promoters. That apart, if it really big, its chain of suppliers and vendors also get affected.

However, if a bank fails it hurts numerous depositors who have kept that money in the bank directly. They all will lose their money. Many would have lost their lifetime savings and means of sustenance. Besides, failure of one bank can hurt many other financial institutions with which it has dealings. The potential havoc that the failure of a bank can wreak could be seen from what happened after the 2008 financial meltdown and the spectre of bank failure in Europe over the more recent financial crises in the European countries, including Greece, Spain, Portugal, Ireland and Italy.

Fearing the widespread financial contagion of a failure of a major bank, the US government had moved in to shore up the capital base of institutions which were facing bankruptcy. The theory was put forward of ‘Too Big to Fail’ banks — meaning those banks whose failure can trigger off a entire financial chain reaction of crises. This is called the systemic crisis.

This is the background against which the Reserve Bank will have to craft its new banking licences policy. The underlying principle is that you cannot take risks with the banking structure and create anything that can destabilise the financial architecture. This is so because the vulnerabilities are numerous. The most important question, which has to be settled in the context, is whether to allow existing large industrial and business houses to start new banks. Why? Because allowing existing large businesses entry into banking can result in conflict of interests. That is, the deposits of a bank — which is money of public at large, promoted by an industrial house — may be diverted into the promoter’s industrial activities without observing the normal caution that a bank should have in lending to any single borrower. Channelling bank’s funds into risky group businesses can jeopardise public interest. There is basically need for firewall between a promoter of a bank and the interests of a large borrower. When the two become the single person, then the firewall vanishes.

Already, a number of large corporate houses are lining up and reportedly doing the basic groundwork expecting that the RBI will allow private corporate entry into new banking. Dr C Rangarajan, former governor of RBI and currently chairman of Prime Minister’s Economic Advisory Council (PMEAC), has observed that when opening up licences for new banks, non- corporates should be looked at initially. That is, existing non-banking financial companies could be considered for licences.

Joseph Stiglitz, Nobel laureate in economics, while delivering the Deshmukh Memorial Lecture in Bombay last week, is reported to have observed that corporates should not be allowed into banking as it has the potential to result in conflict of interests. On the other hand, it is also true that it is the large business houses who have the resources to seriously set up stable banks. After all, until Indian banking was nationalised in mid-1970s, banks were all owned and run by private corporate houses and they ran their respective banks fairly well. Of course, the argument put forward by the then government in taking over these banks was that the banks took care of their interests and did not care for the large concerns of the country like offering loans to small business, for start-ups by weaker sections or give loans to farmers. There are of course, some other equally important concerns while deciding to give new bank licences. The RBI draft policy tabled last year had taken care of some of these. It for example forbade giving licence to real estate companies to run banks, or ruled out giving bank licences to stockbrokers and companies having remote connections with stock broking. The entry level capital requirements have also been raised from Rs 300 crore to Rs 500 crore to make sure that those who wish to enter this business must have the financial muscle power as well as the commitment by putting upfront such money.

But even Rs 500 crore entry levels capital requirement for a new bank looks small by today’s standards. After all, several multiple of Rs500 crore can be moped up in no time by a new bank in no time. This requirement should be raised for corporate entrants by at least ten-fold so that only those who are genuinely interested in running new banks should be coming in.

Today, the Indian banks are much stronger than they were. No action should be taken in haste to undermine the basic soundness of Indian banking. (IPA)
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