Indian corporations in banking is a bad idea: Raghuram Rajan, Viral Acharya

Former Reserve Bank of India's (RBI) governor Raghuram Rajan and deputy governor Viral Acharya have said that the proposals put out by an internal working group (IWG) of the central bank to allow corporate entry into banking is a "bad idea."

Rajan and Acharya, in an article he posted on the former's LinkedIn account, have stated that it is important to "stick to the tried and tested limits on corporate involvement in banking."

The RBI recently released a report by its internal committee that suggested an overhaul of the licencing policy of private banks that included myriad proposals such as allowing corporates to float banks, permitting promoters to hold on to higher stakes, and granting approval to allow large NBFCs to convert into banks.

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Rajan and Acharya  note in their article that the recommendation, to allow corporate houses in the banking sector is a "bombshell" marking out two rationales to support his argument.

First, industrial houses can get loans (financing) easily with no questions asked if they have an in-house bank. Rajan and Acharya explain that the history of such "connected lending is invariably disastrous."

"The RBI recognised the risk of excessive exposures to specific houses in 2016 by announcing group exposure norms, which limit how much exposure the banking system can have to specific industrial houses," former RBI governor and deputy governor enunciate in the article. They add that as the WGI has suggested, "it is always difficult to discern the connections that make a borrowing entity part of an industrial house."

The second rationale Rajan and Acharya give in support of their contention is that the corporate entry into banking will further "exacerbate the concentration of economic (and political) power in certain business houses."

They caution that even if the RBI allots the banking licences fairly, it will allow undue advantage to large business houses that already have the initial capital that has to be put up.

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Rajan and Acharya further highlight that the highly indebted and politically connected business houses will have the greatest incentive and ability to push for licences which will "increase the importance of money power yet more in our politics, and make us more likely to succumb to authoritarian cronyism."

They warn that once a bank licence is given, the licensee's temptation will be to misuse it because of self-lending opportunities. "India has seen a number of promoters who passed a fit and proper test at the time of licencing turn rogue," Rajan and Acharya add.

They also point out that the bailout costs to the exchequer could also be significantly more when it comes to bank licences to industrial houses, "which will start out big."

Recognising the need for additional banking services in India, the ex-RBI governor and deputy governor exclaim that although the country needs more banks, its "credit to GDP ratio is abysmally low." They add that if the RBI aims to bring in more managerial capabilities, the central banks already "allows business houses that don't have more than a certain fraction of their business in non-financial enterprises to apply for a bank licence." Rajan and Acharya ask that if that's the case, then "why not encourage more of these less-conflicted houses to apply for a licence?"

They further state that the RBI also allows business houses to apply for a payment bank licence which allows telecoms and possibly internet platforms to offer deposit accounts, and "if they want to make retails, they can tie up with a bank, and share any resulting profits." Citing this argument, Rajan and Acharya question the need for industrial houses to get full-fledged bank licences.

Speculating if the government wants to expand the set of bidders when it finally turns to privatising some of the public sector banks (PSBs), the former RBI governor and deputy governor term it a mistake. They add that it would be "penny wise pound foolish" to replace the poor governance under the present structure of the PSBs with a "highly conflicted structure of ownership by industrial houses."

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