Say 'no' corporate houses in Indian banking

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Say 'no' corporate houses in Indian banking

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• Big Bang reform: In this era of historic and big bang reforms, perhaps the RBI IWG's recommendation of allowing corporate houses into Indian banking should have been celebrated. But most experts are stunned and worried. [IWG - Internal Working Group]
• Industrial houses into banking: This idea started in 2013, when the RBI issue guidelines that permissed industrial houses to apply for banking licences.

1. Some applied, and some of them withdrew later. None got any licence finally.
2. Only IDFC and Bandhan Bank managed to get it.
3. RBI said none of the corporates had met the "fit and proper" criteria. It cited the risk of breaking public trust as reason for not issuing licences.
4. In 2014, RBI restored the long-standing prohibition on industrial houses getting banking licences. (Governor Raghuram Rajan (RRR))
5. The 2008 Committee on Financial Sector Reforms (Chair - RRR) had clearly recommended a total ban on "banking and commerce combine". It exists in the USA, and till date in India too. 
6. The regulatory capacity to control malfeasance just doesn't exist in India.

• So what's new in 2020: The IWG says industrial houses will bring capital and expertise to banking, and not all countries ban them. 

1. Problem is the huge downside risks. These include - Interconnected lending, concentration of economic power and exposure of safety net given to banks to the commercial sectors.
2. Corporate houses will turn banks into fund-source for their own businesses! They will also lend to their friends. They will support their own customers and vendors too. So their economic power grows enormously, and competition is killed.
3. Such banks will be now exposed to failure of the non-banking businesses of the industrial grop. If any such business fails, the bank's reputation too is clouded and bailouts demanded.
4. The IWG report says that RBI must hae a legal framework to tackle interconnected lending and supervision of conglomerates. It is too innocent to assume that India can build such a structure, against the prevailing political pressure!

• Tracking the lending: To track interconnected lending is a tough job, as corporates are experts in creating a maze of money trails. Various law enforcement agencies will be needed to do it, and a single politician will be able to thwart it when needed. The bigger worry is the ex-post nature of the problem - RBI will react only once such lending HAS happened not BEFORE. And assuming the RBI catches such lending, what can it do? Depositors will run away, causing failure. It's a no win situation for regulators.
• Credibility will die: If we pit the RBI against the most powerful corporates of India, the RBI will be damaged enormously, as it will have to compromise. 
• Two types of corporates: The above is valid for corporates with little existing interests in financial sector. What about those that own NBFCs already? Today NBFCs with a 10 year track record are allowed to convert into banks, but the IWG says that corporate-owned NBFCs can also be allowed to. That's a bad idea, because NBFCs are fundamentally different from banks. NBFCs have no public safety net, but banks have it. So corporates cannot be allowed either in banking or in the NBFCs-to-banking route.
• The real point: Few corporates may show interest in building a bank on their own. They'd like to buy out some existing PSB with poor valuations (due to NPAs). These PSBs are starved of capital that the govt. is not able to provide. So corporates may enter, and privatisation happen. Given the pathetic state of corporate governance in India, one can easily imagine the financial stability risk that will soon arrive.
• Summary: Till date, the struggle was against over-leveraging of corporates, but with their own banks, the road to hell will be ready!

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