Raghuram Rajan, the former governor of the Reserve Bank of India. Photo: AFP

The move by India’s central bank to allow industrial houses to float banks has been sharply criticized by former Reserve Bank of India (RBI) governor Raghuram Rajan and his deputy governor Viral Acharya. They fear it could lead to a concentration of economic and political power in certain business houses.

The RBI’s Internal Working Group stated in a report that large corporate/industrial houses may be allowed to be promoters of banks after necessary amendments to the Banking Regulations Act, 1949, and also proposed raising the cap on a promoter’s stake in a private bank from the current 15% to 26% in 15 years. The committee was formed in June to review ownership guidelines and the corporate structure of Indian private sector banks.

In a joint statement, released on Raghuram Rajan’s LinkedIn page, they said that in the report the “most important recommendation, couched amidst a number of largely technical regulatory rationalizations, is a bombshell.” As for allowing industrial houses to set up banks, they wondered, “Why now? Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking.”

Citing the recent examples of the rescue of Yes Bank and Lakshmi Vilas Bank by the Indian Government, they said that banks in the country are rarely allowed to fail. And for this reason depositors know their money is safe and banks have access to their funds. It may be recalled that since 2018 five financial institutions, including Yes Bank and Lakshmi Vilas Bank, have collapsed, inviting government intervention. The others include Punjab and Maharashtra Cooperative Bank, shadow banker Infrastructure Leasing & Finance Services and mortgage lender Dewan Housing Finance Corporation.

They pointed out that the reason for not allowing industrial houses to set up banks is two-fold. Firstly, it will allow industrial houses an easy access to funds “with no questions asked.” “The history of such connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower.” They felt in these circumstances even a committed regulator will find it difficult to stop poor lending and “the information of loan performance is rarely timely and accurate.”

Secondly, it will lead to a concentration of economic (and political) power in certain business houses, they added. “Even if banking licenses are allotted fairly, it will give undue advantage to large business houses.” They observed that “highly indebted and politically connected” business houses will scramble for these licenses and increase the role of money power in politics and that Indian society is “more likely to succumb to authoritarian cronyism.”

They observed that once a license is given the industrial house’s temptation to misuse it will be high because of self-lending opportunities. “India has seen a number of promoters who passed a fit and proper test at the time of licensing turn rogue,” they stated.

The duo wondered why the Indian government is showing so much urgency to change the regulation. They pointed out that the appendix of the Internal Working Group’s report has pointed out that all the experts it consulted, except one, were against allowing industrial houses to float banks. “Yet it recommends change!” they observed.

They agreed with the report that India needs more banks as its credit to GDP ratio is low. But they also pointed out that Indian banks incur huge loan losses, which ultimately has to be footed by the taxpayer, and allowing corporate houses with “significant conflicts of interest” will further aggravate the situation.

They said it will be a mistake to sell a state-owned bank to an untested industrial house. “Far better to professionalize public sector bank governance, and sell stakes to the broader public – that would help promote shareholder culture, as well as distribute wealth more wisely.”