While connected and circular lending, and credit misallocation and conflict of interest are real risk scenarios, credit crunch especially for MSMEs is also real.
By Ashish Kapur
For decades after the 1962 war, our dominant security theme was not to develop roads along the Himalayan borders to prevent the Chinese from easily marching into the heartland. Even the military considered such ‘no entry, safety doctrine’ as the safest way of border protection. Sane voices argued that, by the same logic, we should not be building roads for development in Delhi either. Thankfully, better sense prevailed!
A similar ‘no entry, best for banking safety’ thinking seems to be dominating our thought process today. Specialists rightly caution us on the possible pitfalls of letting more corporates own banks. Connected and circular lending, credit misallocation and conflict of interest—these are real risk scenarios.
But these should be managed and war-gamed by finding solutions utilising the available talent pool. Governance failure in banks has caused bad debt pile-ups in the system even without corporate ownership.
Credit-starved developing economy
The ex-SBI chairman rightly remarked that while the safest way is to disallow the corporates manage banks, India remains a credit-starved nation. Credit crunch is real especially for our micro, small and medium enterprises (MSMEs)—counted amongst India’s top employment generators.
The NITI Aayog CEO lamented recently that India’s private credit-to-GDP ratio is the lowest amongst global peers. According to BIS 2019 statistics, credit to the non-financial sector as a percentage of GDP stands at 56% in India, as against 150% and 205% in the US and China, respectively. The MSME credit needs are largely unmet by the formal financial sector, leading to an estimated MSME credit gap at Rs 25 lakh crore.
RBI, in September 2020, actively updated/reclassified priority sector norms and MSME definition to enable better credit penetration by banks. Yet we need an all hands-on-deck approach to satisfy latent credit needs of the MSME network encompassing the government, regulators and industry.
With flagging revenues, allocations to pandemic control and emergency purchases to fight security challenges have pushed the government’s hand and accentuated urgency for resource mobilisation through quicker divestment, which is running way behind schedule. Whilst total privatisation is unlikely due to stakeholder outcry, small stake divestment is certainly feasible. For instance, in the IDBI Bank, the government divested 51% majority holding to the LIC and is open to explore sale of its remainder 47% stake even to a corporate or an NBFC.
The importance of RBI Internal Working Group (IWG) recommendations
—Given the aforesaid context, the IWG’s key recommendation of allowing NBFCs with assets of Rs 50,000 crore and a track record of 10 years appears a better way of regulated re-entry of trustworthy corporate houses into the banking system. If reputed, well-managed corporate-owned NBFCs align with banks with a good network but poor management, it will be a win-win solution for the system. Backing of a strong corporate group also reassures depositors of struggling banks. After all, specific regional industrial groups have always enjoyed public trust comparable with banks. For instance, till the early 1980s, Sundaram Finance of the reputed TVS Group had public deposits higher than the deposit base of erstwhile State Bank Madras Circle;
—The IWG has also suggested amending the Banking Regulation Act, 1949, to prevent connected lending and rightly emphasised a consolidated supervision mechanism for conglomerates. It is not that industrial houses owning banks have a freehand in lending to group entities as RBI has sufficient powers to restrict intra-group exposures. RBI can also prescribe a higher risk weightage to ensure that pricing for intra-group lending is not preferential but market-driven;
—Enhancing the MSME network could be another objective for allowing banking licences to professionally-managed corporates with a strong governance background. Agreed, bank licensing is not akin to spectrum auction, nor is developing industry the job of RBI or banks. And yet the expertise of corporate groups in supporting MSMEs to scale up and become reliable suppliers in local/global supply chains needs to be leveraged whilst issuing licences. Given that corporate houses actively build their supplier networks through MSMEs, they have a better understanding of key criteria that can distinguish between a well-run MSME and a poor one—a crucial criteria that many standalone banks lack and, therefore, loss ratios in the MSME segment are much higher for such banks;
—RBI may choose to prioritise licence applications of shortlisted corporate groups, basis their direct and indirect commitment in creating fresh priority sector supplier networks that meet MSME plant and machinery investment definition criteria;
—Alternatively, RBI may prescribe a higher commitment target for corporate-owned banks towards MSME lending. Such higher commitment to the MSME segment can be relaxed based on their RBI audit results on governance and management systems. Preferential licensing based on investment commitment with MSMEs may be difficult for banks to drive, although differential priority sector commitments could certainly help drive behaviour;
—The critics’ fear of corporate houses lining up to enter the banking fray is a fallacy. In fact, five of the 12 banks granted licences in 1993-94 and 2013-14 failed, implying a high fatality rate of more than 40%. Banking is not so lucrative a business, after all. On-tap universal bank licence norms have existed for some time. The biggest worry for any new private bank is building a cost-efficient liability base, besides meeting stringent priority sector obligations. Promoter groups would invariably need to support fledgling bank franchises with group deposit accounts initially.
With RBI mandating 40% of a bank’s lending be directed towards priority sector like MSMEs, agriculture and weaker sections, many corporate houses remain wary about such directed credit allocation targets. Only serious contenders with a governance track record will gain RBI’s nod. Even so, the importance of keeping out highly indebted industrial groups with a poor track record from licensing cannot be ignored;
—Perhaps a shortlisted and negative list of promoter groups can be created—something that is not difficult for RBI. Whenever any bank faces a crisis and intervention becomes imminent, like in recent instances of the Lakshmi Vilas Bank and the YES Bank, RBI any way has a conversation with chosen names for bailouts.
Unethical practices in any bank have to be punished with a heavy hand as integrity and probity are paramount in banking. Strong legal action initiated recently for financing frauds and resultant NPAs in the banking system needs to be taken to a logical conclusion.
The author is a certified treasury manager and credit & relationship banking veteran of BNP Paribas, FirstRand, Global Trust and L&T Financial Services