Tag: Banking Regulation Act

The Reserve Bank of India has disappointed big corporates that are looking to enter the banking sector, as it kept in abeyance the proposal of its internal working group to allow large industrial houses in the sector.

RBI said it had accepted 21 recommendations with some modifications of the 33 proposed by the committee in November last year. The most contentious proposal by the five-member panel was to allow large corporate houses as promoters of banks after amendments to the Banking Regulation Act. Experts pointed that RBI would face challenges in supervising non-financial sector entities, and supervisory resources could be further strained.

Former RBI governor Raghuram Rajan and deputy governor Viral Acharya were foremost among the experts who had opposed the proposed move last year.

“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 regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending,” they said in a joint article. In August 2011, the then RBI Governor D. Subbarao said in one of his speeches, “by far the biggest apprehension is about self-dealing — that companies will use the bank as a private pool of readily available funds.”

The argument against

While corporates can bring in capital, business experience and managerial competence, the biggest risk of allowing industrial houses to promote banks is the conflict of interest. A bank is an intermediary which channels public deposits to borrowers. It was not easy for supervisors to prevent or detect self-dealing or connected lending as banks could hide connected party or related party lending behind complex company structures and subsidiaries or through lending to suppliers of promoters and their group companies. RBI also has had an unsatisfactory record in its role as the banking supervisor. Recent governance failures in private banks can be traced to a lack of independence within the board.

The current status

Individuals and companies, directly or indirectly connected with large industrial houses, can participate in the equity of a new private sector bank up to 10 per cent but without controlling interest in the bank. Such shareholders are not allowed to have any Director on the board of the bank on account of shareholder agreements or otherwise, according to the RBI Guidelines for ‘on tap’ Licensing of Universal Banks in the Private Sector issued in August 2016. A group with assets of Rs 5,000 crore or more with the non-financial business of the group accounting for 40 per cent or more in terms of total assets or in terms of gross income, will be treated as a large industrial house, the RBI said.

Tech disruption

The real transformation in banking is coming from tech companies. A core function of traditional banking, payments, has already been disrupted by fintech. Now, Big Tech is pushing the envelope in financial intermediation. Data is central to the digital economy. It’s given Big Tech an opening, leading to the so-called DNA (data-network-activities feedback loop) advantage. Navigating the risks here is the emerging regulatory challenge. In this situation, there’s no pressing need to add another risk in terms of allowing industrial houses to promote banks.