Corporate-Owned Banks

FEB 17

Mains   > Economic Development   >   Indian Economy and issues   >   NBFCs and other banking

IN NEWS:

  • An internal working group set up by the Reserve Bank of India to review ownership structure of private lenders has recommended allowing industrial houses to control banks.

CORPORATE-OWNED BANKS:

  • Before the nationalisation of banks in 1969, India’s banking system was in the hands of the private sector. Most of the privately-owned banks were in the form of joint-stock companies controlled by big industrial houses.
  • Since the nationalisation of 14 large private banks in 1969, the RBI has not given licenses to large corporate and industrial houses for setting up banks even though a 2013 guideline briefly allowed it.
  • At present, the private banks in India have majority of ownership held by individuals and financial entities.
  • There are several NBFCs promoted by large corporate groups. But unlike banks, NBFCs are not allowed to accept demand deposits from public depositors and they are also not part of the payment and settlement system.

WHY INDIA NEEDS SUCH BANKS:

  • Untapped financial resource: Given the growth imperative, India is in dire need of capital. Corporate houses, some of which have substantial investible capital, constitute one of the largest untapped domestic sources of new investment in banking.
  • Need for more capital: Currently, the quantum of bank credit remains woefully inadequate. For eg: In 2018, domestic credit to the private sector by banks as a proportion of GDP was just 50% in India. In comparison the proportion was 158% in China, 141% in South Korea, 112% in Thailand, 81% in Chile, 66% in South Africa and 61% in Brazil.
  • Boost employment generation: The most credit-starved sectors are road construction, real estate, housing, hospitality, manufacturing and tourism. These sectors provide maximum employment opportunities for the less privileged.  
  • Risk taking behavior: Today’s Public sector banks are averse to risk-lending. Bank officers, being easy targets, are hesitant to provide credit under fear of scrutiny at the hands of the CBI, CVC and courts. However, corporate business houses are much more risk taking in nature.
  • Adapt to modern banking: New age fintech business models thrive at the intersection of telecommunications, digital consumer services and finance. Realizing this, countries such as Singapore have recently issued full banking licences to companies operating in the telecom and digital sectors.
  • Shorter break-even time: Corporate houses have a strong base of investors and customers, whom they can pull in as depositors. Hence, unlike newly established  banks, corporate owned banks can shorten the road to profitability, without having to take on excessive asset-side risk.

WHY INDIA DO NOT NEED SUCH BANKS:

  • Poor track record in India: Corporate owned banks of pre-nationalization era have a poor history. As promoters of private banks, corporate and industrial houses used to channel large sums of low-cost depositors’ money into their group companies. This eventually led to concentration of banks in few pockets and even failure of several banks.
  • ‘Circular banking’: Under circular banking, a corporate-owned bank A would finance the projects of corporate-owned bank B, B would finance the projects of corporate-owned bank C, and C would finance the projects of A, hence completing the cycle. Such a cycle was prevalent in India before nationalization.
  • Vulnerable to shocks: Private banks are more vulnerable to global economic shocks than government-owned banks. The failure of several banks following the Financial crisis of 2008 stands as an ominous example.
  • Increases economic inequality: A few large corporate houses control a substantial part of our national assets. The emergence of corporate-owned banks will only enhance the rise of economic oligarchs in key sectors of the country. A democratic country cannot afford such situations.
  • Conflict of interest: If industrial houses are licensed to set up banks, they will ensure that a large part of the credit goes to their relative subsidiaries and other connected enterprises.
  • Global aversion: Globally, regulators do not encourage the entry of large corporates into the banking sector mostly due to governance and financial stability concerns. Experiments in other countries allowing industrial houses to set up banks have failed miserably. The United States (US) does not allow corporate houses to set up banks.
  • Weak regulatory environment: The emerging scandals like Yes Bank and Infrastructure Leasing & Financial Services Limited (IL&FS) have discredited both the banking system and the manner in which it is regulated. They have questioned the effectiveness of RBI’s oversight mechanisms.
  • Potential avenue for money laundering: The pervasive use of shell companies and offshore ownership structures have made it easy for corporates to circumvent any regulatory measures put in place by authorities. Corporate-owned banks can aggravate this situation.

WAY FORWARD:

The contribution of the banking sector is very vital for economic growth and poverty reduction strategies. Hence, too much is at stake, and there are better sources of mobilizing capital to meet the funding needs of the Indian economy other than corporate houses. Also, the RBI’s existing supervisory mechanism is still behind the curve in ensuring real-time compliance and early detection of frauds. To avoid these, the problem of effective implementation needs to be addressed.

If the idea is to be prospected, the risks should be mitigated through proper guardrails and strict monitoring. These banks should have a clear separation of management from ownership and should be subject to some unique governance rules. A stronger presence of independent directors on the board than regular banks is one such example.

PRACTICE QUESTION:

Q. Solving the acute problem of credit deprivation faced by India demands a recourse of its banking sector. In this regard, critically examine the idea of corporate-owned banks in India?