RBI Should Let Business Houses Set Up and Run Banks

Context: Amidst the economic downturn, revitalising the banking sector by allowing private entities to open banks would outweigh the Financial Stability Risks in the economy.

Recent Steps were taken by the Reserve Bank of India:

• Announced one-time debt restructuring
• Enhanced the loan-to-value ratio of gold loans to 90% after the prices of gold reached a historic high.
• Shut the doors for Indian corporate houses wanting to set up banks due to governance challenges.

Issues in the Banking Sector:

• Limited capital and limitless ambition of founders: Banking structure and credit disbursement have been challenged by the gross misconduct of the founders:
• For E.g. In 1969, when banks were nationalized, they had largely served as financing vehicles for the industrial houses that promoted them.
• The recent experience of Punjab and Maharashtra Cooperative Bank having diverted a huge proportion of credit to a favoured borrower. 
• Low public sector growth: Due to over-regulation in the case of public sector banks, the following challenges exist:
• Low ratio of credit to gross domestic product.
• Rising frauds in government-owned banks, faster than asset creation.
• A negative return on equity and assets in 2017-18 and 2018-19.
• For E.g. Nexus between banks and clients led to the downfall of demonetization outcomes.

• Conflict of interest: Government finances are not meant to provide capital for commercial enterprises.

• It only encourages political and executive interference in commercial decision-making, giving rise to conflicts of interest

• No system of incentives/disincentives for orderly debt behaviour: Corporate houses routinely delayed payments to banks.

Way Forward: Encouraging Private Sector Banking – will have the following advantages:

• Reducing the share of government-owned banks:
• Reducing the scope for them to run up bad assets every few years.
• Avoids diversion of taxpayer money towards recapitalization and away from the developmental needs of the country.
• Fulfilment of capital needs: A capital-intensive industry needs players who can invest large amounts of capital.
• For E.g. This has happened with the steel, telecom and aviation sector –
• Consumers have benefited,
• Huge investments have come in, 
• Prices have come down, and
• Conflicts of government ownership have been eliminated substantially.
• Putting disincentives on late payments: Public disclosure of even a day’s delay in payments to banks for publicly listed companies, as is done in the case of bonds and marketable debt.

Conclusion: Regulatory policies should facilitate the growth of the sector and ensure its stability. But, developing economies that focus exclusively on either of the two goals will enjoy neither.