Internal Working Group’s Recommendations on new Banks: Are we protesting too much?
(By S. Shivaswamy, Insolvency Professional & Ex-Bank Executive)
The RBI’s Internal Working Group’s recommendation to allow Corporate houses into Banking has attracted criticism from vide spectrum of public & professionals including some well-known Bankers, economists, public intellectual besides politicians, who have termed it as disastrous to the economy. One well-known public figure but a unsuccessful businessman has likened the idea of Corporate owning a Bank to a “fox holding keys to the henhouse”. The cynical remarks laced with scepticism from the general public due to their poor understanding of matters concerning public finance is understandable. However, the vehemence with which Dr. Raghuram Rajan and Mr. Viral Acharya, Ex- Governor & Dy. Governor of RBI respectively have reacted by terming it as a bad idea and “bomb shell” is rather strange. Considering their professional background and their first-hand experience of the working of the Apex body, their criticism deserves to be pondered over and analysed. Let’s first take a look at the following salient features of IWG’s recommendations:
- The recommendations stipulate minimum initial Capital of ₹ 1000 crores for a Universal Bank and ₹300 crores for Small Banks and Payment Banks.
- Recommendations suggests Corporate houses to float Banks through Non-Operative Financial Holding Companies with promoter’s equity in the long run raised from 15% to 26%. All the Banks in due course, including those licensed prior to 2013, to migrate to NOFHC structure after achieving Tax Neutrality status.
- IWG also suggested uniform cap of 15% to all types of shareholders to prevent concentration of voting rights in the hands of a few.
- Well-run NBFCs with an asset size of ₹ 50,000/- crores may be considered for conversion into Banks.
It is not clear as to what is so radical in the above-mentioned recommendations to warrant such reaction from Dr. Rajan & co. Considering their credentials and background it was expected that their criticism would be more nuanced and marked with professional restraint. Regrettably their opposition to the IWG’s recommendations, by their reference to concentration of economic(political) power, seems to be driven more by frustration than conviction. Their statement that “it is important to “stick to the tried and tested limits on corporate involvement in banking” suggests status quo on the issue. That would have been okay if things were normal and Banks discharging their responsibility of providing credit to the needy. Alas! the Banking system that is expected to carry blood (money) to the different sectors of economy is afflicted with blockages with its capacity to deliver severely impaired. There is an urgent need to find viable alternative Institution to fuel growth of the economy. In such a scenario If not the Corporate Houses who else has the wherewithal to raise ₹ 1000 crores equity to set up new Banks?
Dr. Rajan has expressed apprehension that “industrial houses can get loans (financing) easily with no questions asked if they have an in-house bank” and further goes on to explain “”connected lending is invariably disastrous.” Hence Rajan/Acharys duo are in a way conceding that connected lending have been very much a reality and despite their being at the helm they could do precious little to prevent it! So, in short the Corporate could not be kept away from influencing the Bank or from “Managing Bank Management”! It will be bit churlish to assume that a Corporate wouldn’t leverage his position to get credit on favourable terms regardless of his position vis -a -vis lending bank. That per-se should not be a problem. But the problem arises when Banks under the full glare of supervision from the Apex Bank start pandering to the dictates of the crony capitalists or overbearing Minister’s demand to dole out public money for dubious persons/project , keeping their eye closely shut. The Central Bank’s guidance that should be available to Banks at such vulnerable moments was found missing in the past.
All these years though large Corporate Houses themselves didn’t own any Bank, barring a few exceptions like Kotak Mahindra Bank, the corporates have retained their influence on the working of Banks and even Apex Bank. Most of the top honchos of the Corporate world are nominated to the boards of different Banks/FIs, with the full approval of the RBI, as independent directors. Once inside the Board room, they rub shoulders with political class and bureaucrats and influence decisions in their subtle way. Whether Dr. Rajan could stop such practices during his tenure? Besides it needs to be answered by the RBI as to why such time-tested measures has stifled the credit growth in the country and kept big chunk of population outside the Banking services as Financial Exclusion group. And what is solution to provide finance to the credit starved burgeoning young & impatient population?
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.” Recognising the need for additional Banking services, Dr. Rajan/Acharya go on to ask then “why not encourage more of these less-conflicted houses to apply for a licence”. The duo has not named who the less conflicted houses are! However, it is clear that their objection is not so much against the entry of Corporate House per-se but against “some powerful group” that holds/may hold political influence. Whether Dr. Rajan can guarantee that these less conflicted houses will not turn rogue in future as feared by him?
Dr. Rajan, when handpicked as the Governor, after his role as the Chief Economic Advisor, was expected to help revitalise the Banking system and fuel the growth of the economy. Dr. Rajan , known as Rockstar banker, was a toast of the nation, with everyone looking up to him to perform miracle! Actually, his period at the helm and just prior to that saw the wholesale loot of the public money through Banking system into speculative real estate and other projects of dubious nature resulting in unprecedented rise in the loan loss provision. Dr. Rajan has admitted to the existence of middle men and money being exchanged for favouring business houses . RBI’s prescription in the form of ill- timed and ill- advised directives on AQR further turned the Banks into moribund organisation. If AQR were to be introduced as a tool for self-discipline and Governance it should have been done in 2006/07 when NPAs were almost wiped out from Bank’s books. As for its impact RBI’s , AQR was no better than Modi’s demonetisation drive .
We need to first understand the nature of Bank’s business in order to understand the role of the Corporates in Banking. When the doors of liberalisations were thrown opened for FDI in various sectors money started pouring in from all corners and consequently banks were also flooded with excess liquidity. Interest rates started moving southwards even as the Banks continued to be saddled with idle cash. Banks initially posted exceptionally huge profits riding on the unprecedented treasury income on the back of plummeting interest rates and utilised it to wash off past sins parked in their book as NPA. But the problems of excess liquidity continued to persist. RBI took note of this unique position in India Banking system and encouraged Bank’s to adopt more pro -active stance. RBI issued guidelines for Diamond policy and lending to sensitive sectors consisting of Real estate, Infra and Stock market etc. Import of Gold by private jewellers outside the control of canalising agencies like MMTC was allowed which contributed massively to trade deficit and unbridled inflation. Cap on sanction of Term/Project Loans by Commercial Banks, hitherto a domain reserved for development Banks, was removed. Risk appraisal and viability of the project was highly compromised and lending became just another way of investing idle cash. Bank continued to dole out money into the hands of willing Corporates, deviating from laid down policies, more as a rule than exception, without any justification. The Corporates gladly accepted it only to splurge in a most conspicuous way. In many cases promoters didn’t even bring in their equity but still got the full loan amount released. Dr. Rajan has himself admitted once in an interview to a news channel that in many cases full equity was withdrawn even before first brick was laid. When one fine day the bubble burst, everything fell down with a big thud leaving a gaping hole in the Banking system. The big corporates like fair weather friends fled to some safe haven taking advantage of the systemic loopholes and ably aided by their moles at important places, planted and cultivated over the years.
Dr Rajan/ Acharya duo may well argue that when without any ownership stake the corporate could wreak such a havoc then their de-jure ownership will be much more catastrophic. This is like barking the wrong tree. The issue is of governance and supervision not of ownership. The supervision is a third pillar of Risk Management tools, to be judiciously used by the Regulators. Besides the conduct and post sanction follow up of loan is the responsibility of the Banks not Corporates. RBI instead of cautioning the Banks about the inherent risk in such reckless lending, encouraged Banks to freely poach on other Bank’s business by sometimes undercutting and sometimes going for multiple banking arrangement. In a few cases, the excessive indulgence of the Banks by offering to convert Debt into equity only emboldened them. The idea of equity participation was to cash on the upswing but Banks held on to it till it turned into penny stocks!
Why only Corporates should be blamed for the mess? Besides, if such analogy is extended further Corporates should not be allowed in other fields also. When constitutionally there is no bar on the Corporate to enter politics, get elected and even become Finance Minister controlling the entire Financial & Banking system then why so much fuss on their jointly owning a Bank! If Corporate Houses are allowed to enter Insurance Sector and own NBFCs, with or without deposits, why there should be a opposition to their entry in Banking sectors alone? Kotak Mahindra Bank & Bajaj FinServices are examples of Corporate’s successful foray into Banking sector. Today Banking Sector is starved off Capital rendering them incapable of extending finance to emerging sectors mainly due to reckless lending in the past.
A corporate house owning maximum of 26% voting share can’t make much difference. But his ability to influence other stakeholders notably bureaucrats and politicians, even without any voting share needs to be effectively checked. It should not be overlooked that there are many corporate houses known for excellent management and organisational capacity. Here the role of the Apex bank become critical. By introducing necessary amendments in the Banking Regulation Act, corporate can be barred from in-house financing of owners group and other related party entities. Besides effective checks are to be put in place to prevent cartelisation of Banks. It was well known in the Banking Circles all these years that the much-fancied Private Sector Banks were acting as conduit for unscrupulous business houses to siphon off the money meant for project finance. Why RBI failed in its duty to issue strict advisory on the of opening of Current Accounts by corporates, to prevent diversion of resources?
We need to acknowledge the fact that the Economy is passing through an extremely difficult phase and that is further exasperated by Covid driven pandemic. Banks have lost ability to lend at a time when there is a greater need to pump credit into the economy to revive growth and job prospects. It is high time some innovative methods are designed to provide necessary credits to the needy. A new Bank, under Non-Operative Financial Holdings Company, with proper safe guards or a well-managed NBFC converted into Bank can fill the gap and extend much needed credit to the entrepreneurs. Corporates have a role to play in the nation building in as much as by any other sector/group including Regulators.