Corporates owning banks: S&P, Raghuram Rajan red-flag concerns

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November 24, 2020 8:15 AM

The Reserve Bank of India (RBI) working group’s recommendation to allow corporate houses to own banks has drawn sharp reactions from experts, who have red-flagged risks associated with such a move.

rbi, reserve bank, state finances, gdp growth,Corporate ownership of banks raises the risk of inter-group lending, diversion of funds, and reputational exposure.

The Reserve Bank of India (RBI) working group’s recommendation to allow corporate houses to own banks has drawn sharp reactions from experts, who have red-flagged risks associated with such a move. Rating agency S&P Global on Monday said it was sceptical of allowing corporate ownership in banks given India’s weak corporate governance amid large corporate defaults over the past few years. “In addition, RBI will face challenges in supervising non-financial sector entities and supervisory resources could be further strained at a time when the health of India’s financial sector is weak,” the ratings agency said.

Former RBI governor Raghuram Rajan and ex-deputy governor Viral Acharya argued against allowing companies to own banks because it would allow non-financial businesses to gain easy access to financing and encourage connected lending and because it could lead to further concentration of economic and political power in certain business houses. In a LinkedIn post, Rajan and Acharya also laid out likely motivations for the recommendations, the first being to enable the privatisation of PSU banks.

This objective is better achieved by professionalising governance and letting the broader public own larger stakes in these banks, they argued. The other possibility, they said, is that a particular corporate house which holds a payments bank licence now wants to convert into a full-service bank. The two were surprised the working group had recommended corporate ownership of banks even though only one among all the experts they consulted favoured such a move. “Why is there urgency to change the regulation? After all, committees are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?” they asked.

S&P analysts were of the view that the working group’s concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks. Corporate ownership of banks raises the risk of inter-group lending, diversion of funds, and reputational exposure. “Also, the risk of contagion from corporate defaults to the financial sector increases significantly,” S&P analysts wrote, adding that non performing assets for the corporate sector stood at around 13% of total corporate loans as of March 2020, highlighting the more pronounced risk in India compared with other countries.

The possibility of eventually privatising larger swathes of the state-owned banking universe through this route is a real one, experts said, but that would require major legislative changes. R Gandhi, former DG, RBI, said any changes would only take place over the medium term and the legislative and regulatory adjustments would need to address two concerns. “One concern will be that business houses owning a bank should not be able to dictate terms or over-influence the operations of the bank. There will have to be a distinction made between economic interest and controlling interest,” Gandhi said. In other words, the first legal task will be to ringfence the promoter from the operations of the bank. “The second concern is whether the bank’s resources will be diverted for the benefit of the promoter or their group companies. I would expect the legislative changes to be addressing these two concerns,” he added.

In addition, the supervisory framework would also need to undergo changes. Sanjay Doshi, partner and head, financial services advisory, KPMG, said: “The licenses will be very selective and will go through a very stringent review and filtering process. Further this will need to be backed by scaling up supervision team including leveraging technology to enable data analytics based supervision.”

Monish Shah, partner, Deloitte India, said given the level of underpenetration of financial services in India, the proposed new bank licences are likely to create a supply-side push to attract private growth capital to the credit market. “As a part of the structural reforms that we have witnessed in the sector over the last few years, new licencees are likely to leverage India’s data dividend and help build mobile-first digital challenger banks. RBI is expected to put a robust screening process and strong governance to ensure independence of the licensees,” he said.

Corporate houses owning non-bank lenders have welcomed the working group’s recommendations.

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