Two former central bankers have questioned the recent recommendation by a Reserve Bank of India (RBI) working group to allow large business houses to run banks.

In a scathing piece, former governor Raghuram Rajan and former RBI deputy governor Viral Acharya described the RBI working group’s most important recommendation—letting businesses own banks—as a ‘bombshell’.

Last week, an Internal Working Group (IWG), set up by the RBI, recommended changes in private bank ownership guidelines and entry norms for corporates.

Part of the proposals was that large NBFCs could convert to banks and large businesses can be considered for setting up banks. To be sure, these are recommendations, not guidelines. The RBI will take final guidelines based on this report.

Timing questioned

But Rajan and Acharya said, while the proposals are tempered with many caveats, these raise an important question. “Why now? Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking?” the authors asked.

In the past, the RBI has been largely hesitant to let large businesses promote banks.

Rajan and Acharya question the urgency and timing of the Working Group proposals. “After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?” the authors asked.

In the appendix, the IWG report states that all experts it consulted barring one has opposed the idea of corporate entry into banking. “Yet, it recommends change,” the authors noted.

The IWG proposals have come with certain riders. According to the IWG recommendations, large corporate/industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulation Act, 1949.

This is aimed at preventing connected lending and exposures between the banks and other financial and non-financial group entities and strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision.

Rajan and Acharya aren’t very confident that these changes will be enough to guard the banking sector. “If sound regulation and supervision were only a matter of legislation, India would not have an NPA problem,” Rajan and Acharya said.The authors have lauded 'many of the technical rationalizations' proposed by the working group but its main recommendation –letting corporates in banking—“is best left on the shelf,” they said.

However, Rajan and Acharya aren’t very confident that these changes will be enough to guard the banking sector. “If sound regulation and supervision were only a matter of legislation, India would not have an NPA problem,” Rajan and Acharya said.The authors have lauded 'many of the technical rationalizations' proposed by the working group but its main recommendation –letting corporates in banking—“is best left on the shelf,” they said.

Explaining the risks in corporates running banks, Rajan said, corporate houses can use the banks floated to get fund when they need. Also, the regulators can succumb to political pressure or the urgency of the moment.

“The history of such connected lending is invariably disastrous—how can the bank make good loans when it is owned by the borrower?” Rajan and Acharya asked. The RBI has allowed universal banking licences to be on-tap basis since 2016. But, no licences have been issued since 2014.

In the previous rounds, when the RBI had issued private bank licences, the banking regulator had permitted corporate houses to apply, but turned down their applications, and preferred financial institutions which had experience in banking transactions.

The last time (2013-14) when the RBI invited applications for new private banks, a host of corporates including Tata Sons; the Aditya Birla Nuvo, part of the Aditya Birla conglomerate; L&T Finance Holdings, part of India's largest engineering conglomerate Larsen & Toubro; Reliance Capital; and INMACS Management Services Ltd, which provides management consultancy, corporate finance, audit, tax, and legal advisory services, had applied for permits.

Only Bandhan and IDFC got licences.

The RBI has issued bank licences in three rounds since liberalisation. In the first round in 1993-94, the RBI gave licences to 10 private sector banks, namely Global Trust Bank Ltd, ICICI Bank Ltd, HDFC Bank Ltd, UTI Bank Ltd (renamed Axis Bank Ltd), Bank of Punjab, IndusInd Bank Ltd, Centurion Bank Ltd, IDBI Bank Ltd, Times Bank, and Development Credit Bank Ltd. Some of these banks do not exist now as they were acquired by stronger banks.

In 2003-04, two more banks were given licences—Kotak Mahindra Bank Ltd and Yes Bank Ltd. In 2014 IDFC First Bank and Bandhan Bank were given the licence. Rajan and Acharya listed some of the potential reasons for not letting corporations enter banking.