Corporate Houses Setting Up Banks? An RBI Group Feels It’s Time To Open Up

Why is an internal committee at RBI recommending entry for large corporates into banking?

A customer uses an HDFC Bank Ltd. mobile automated teller machine (ATM) van in a residential neighborhood of Mumbai. Photographer: Dhiraj Singh/Bloomberg
A customer uses an HDFC Bank Ltd. mobile automated teller machine (ATM) van in a residential neighborhood of Mumbai. Photographer: Dhiraj Singh/Bloomberg

An internal working group set up by the Reserve Bank of India has recommended that large corporate or industrial houses may be allowed to set up banks in India. According to the group, headed by RBI Central Board Director PK Mohanty, such a move can be allowed once the Banking Regulations Act is amended and the supervisory wing of the regulator is thoroughly strengthened.

The strengthening of the infrastructure governing private lenders in India would be essential to prevent connected lending and exposures between banks and other financial and non-financial group entities, the group said in its recommendations.

A large corporate, industrial, business house in this context means a group having total assets of Rs 5,000 crore or more, where the non-financial business of the group accounts for more than 40% in terms of total assets or gross income.

A Cautious Approach

The working group report notes that the RBI has always been cautious of the serious risks, governance concerns and conflicts of interest that could arise when banks are owned and controlled by large corporate and industry houses.

In 2013, when the RBI announced that it would be issuing new universal bank licenses, it had decided to allow corporate entities to apply. Certain large corporates applied for a license under this new policy of which few entities withdrew their applications. Eventually only IDFC Bank Ltd. and Bandhan Bank Ltd., both from the financial services sector, were given permission to set up banks, the report notes.

According to Anand Sinha, former RBI deputy governor, who was closely involved with the licensing process in 2013, none of the corporate applicants cleared the criteria set by the central bank.

“The issue of allowing large corporate houses to set up banks in India has always been a very divisive issue...the internal group has revived the concept but not till the supervisory framework and the legal infrastructure is strengthened fully to protect the system,” Sinha told BloombergQuint. “We should expect a vigorous debate on the recommendations due to their far-reaching nature.”

The working group in its report noted that allowing large companies to promote a bank heightens the risks of misallocation of credit, connected lending, extensive anti-competitive practices, and exposure of the government safety net established for banking to a broad range of risks emanating from commercial sectors of the economy.

“Further, all the risks relating to intra-group transactions and exposures, which are existent even otherwise, like transaction risks, moral hazard risks, risk of contagion, risk of reputation get highly magnified in case on corporate ownership of banks,” the report noted.

The Other Side

On the flip side, the working group report notes that large corporate houses can be an important source of capital and can bring in their experience, management expertise, and strategic direction to banking. It’s also a fact that many of them have been successfully operating in other financial segments. The group also noted that internationally, there are very few jurisdictions which explicitly disallow large corporate houses, and even in these jurisdictions, it’s not a settled issue.

Thus, the working group noted that while large corporate houses may be allowed to enter banking, a cautious approach involving better legal and supervisory infrastructure would be essential.

“Once money enters a large corporate group, it’s very difficult to estimate where it has flown,” said Pratip Chaudhuri, former chairman, State Bank of India. “The RBI couldn’t appropriately supervise Rana Kapoor, it’s unlikely that they would be able to supervise complex industrial houses with multiple subsidiaries.”

According to Chaudhuri, waiting for the RBI to strengthen its supervisory infrastructure to be able to regulate corporate entry into banking is likely going to be a long one.