On 20/11/2021, the Reserve Bank of India released the report of the Internal Working Group (IWG) that reviewed the existing licensing and regulatory guidelines relating to the ownership, control, and corporate structure of private sector banks in India
While stressing the term “Non-Operative Financial Holding Company (NOFHC)”, the report also suggested that large corporate houses be allowed to promote banks followed by the necessary amendments in the Banking Regulations Act, 1949.
What is the reason for such a recommendation?
India has a bank-based financial system. The contribution of the banking system is very important for the economic growth of the country.
The country needs capital to grow but the government keeps diverting money from taxes towards the public sector undertakings and government-owned banks are unable to contain their Non-performing assets. As Shekhar Gupta, Editor-in-Chief of The Print, said, “There is too little lending in India”.
India is unable to lend out money either to individuals, businesses, or startups. Private houses with financial resources are suspected to be able to provide said capital in the economy and improve efficiency as well.
So what is the issue?
The recommendation poses several issues which is why the recommendation by the IWG is under a lot of criticism. As Mr. Shekhar Gupta pointed out in an explanation, "Banking is a business involving trust".
The deposits of the public are received by the banks on account of the trust that the general public has for the bank. The involvement of large corporate houses may initiate practices such as connected lending in the banking system.
For the unversed, Connected Banking is a situation where a promoter of a bank is also a borrower at the bank. Furthermore, Circular Banking is also a possibility. This is where one bank (say, Bank A) needs money so it is financed by a different Bank (say, Bank B). For the same, the second Bank is financed by a third Bank (say, Bank C). Finally, the third Bank is financed by the first Bank (A to C).
Other concerns by involving Corporate Houses into Banks are conflict of interest, the concentration of economic power, diversion of funds, and financial instability. These are all potential risks. Furthermore, when IWG turned to its own experts for their views on the matter, all barring one were of the opinion that large industrial/corporate houses should not be allowed to promote a Bank. "
So why recommend it at all?
The above chart from the RBI report shows how the public sector banks have been losing against the private sector banks. Naturally, Private sector banks operate more efficiently and have a larger risk appetite, hence are more profitable. It is in this context that IWG was asked to suggest changes that would benefit the country's banking system.
What is the IWG doing to minimize the aforesaid risks?
The IWG has recommended in its report to allow large corporate houses to promote banks but after amending the Banking Regulations Act, 1949.
Another recommendation is to set the cap of promoters' holding at 26%, instead of the current holding of 15% over a span of 15 years. There is also the recommendation of a cap of 15% on non-promoter shareholding for all types of shareholders. The NOHFC is recommended to be the preferred structure for all new licenses to be issued to universal banks.