A Capital Mistake

Context:  An Internal Working Group (IWG) of the RBI has recently made a far-reaching recommendation to permit industrial houses to own and control banks.

Benefits of the move: the main benefit is that industry-owned banks would increase the supply of credit, which is low and growing slowly.

Reasons for not allowing Industry owned Banks :

• Ignored the opinion of experts: Most of the experts are of the opinion that large corporate houses should not be allowed to promote a bank as there are less benefits and more risks.
• Engagement in connected lending: Corporate banks engaged in connected lending lead to the following adverse outcomes:
• Over financing of risky activities: Banks will start lending to corporate groups to finance for risky activities not easily financeable through regular channels.
• Delay in exit: If industrial houses get direct access to financial resources, their capacity to delay or prevent exit altogether will only increase.
• Entrench the dominance of Industrial houses: If large Industrial sectors get banking licenses, they will be able to entrench their dominance in the whole Industrial spectrum.
  • g. A corporate house may assume dominance in the payments space and use it to dominate the e-commerce space.
  • Power acquired through banking license would make them stronger relative to regulators and government leading to a vicious cycle of dominance breeding more dominance.
  • It will undermine the rules-based, well-regulated market economy, as well as democracy itself.
• Regulation of connected lending is impossible: Experiences in other nations (Indonesia) showcases that regulating connected lending is impossible.
• Increased burden on regulatory bodies: Already the Reserve Bank of India (RBI) is dealing with many banking irregularities at banks like Punjab National Bank and Yes Bank.
• Quality of credit will suffer: Granting banking licences to corporates and allowing them to determine how credit is allocated, will abandon the long-held objective of efficient resource allocation.

Way Forward:

• Smoothening the credit flow: through the creation of new banks and to promote more good quality credit is to undertake serious reforms of the public sector banks.
• Strengthening the regulation: supervision to deal with the current problems in the banking system before they are burdened with new regulatory tasks.
• Repair fiscal positions: after the considerable damage done by the COVID-19 pandemic before the government takes the risk of assuming an enormous future cost.

Conclusion: Policymakers should not mix Industry and finance as it will set us on the road full of dangers for growth, public finances and the future of the country itself.