Experts might be right on bank licensing even if their logic isn’t

Context: While the Internal Working Group’s (IWG’s) suggestions are feared over the security of the financial system, its suggestions may prove to be helpful once the economy has regained footing.

Arguments favouring the entry of corporates in banking:

• It can be thought of as “augmented NBFC license”: Since there is no bar on such licences accepting deposits from the public.
• Robust criteria for application: The IWG notes that RBI has the flexibility to impose additional rules to assess an applicant’s “fit and proper” status.
  • In 2013, no corporate applicant for a bank licence met the ‘fit and proper’ test.
• Corporates are safer than professional: Out of the six failed/merged/troubled banks, four were run by professionals, one by a financial institution and one by a corporate.

Issues with the entry of corporates in banking:

• Rising NBFC failures: due to inadequate supervisory role played by the RBI.
  • Concerns over the security of bank deposits: The resolution process proposed for winding up banks sowed doubts in depositors’ minds about the safety of their deposits.
• Warning by experts: Of all the experts to whom the IWG consulted, the only one did not find anything wrong with the idea of corporate groups promoting banks.
• Lame safeguards: The Internal Working Group(IWG) did not suggest that a corporate promoter must fully divest its stake before it could apply for such a licence.
• Timing of the proposal: has been an issue as India is already reeling under the pressure of following problems:
  • Potential incremental instability seems unavoidable over the next two to three years.
  • Internal resistance will likely make RBI hiring qualified supervisors at market salaries a non-starter.
  • Scheme for rewarding loss prevention has problems wherein if deposit insurance premiums are set higher for new promoters, it would not be a level playing field, and might lead to adverse selections.
  • Low credit growth: credit growth is anaemic now due to weak demand.

Way Forward:

• Fix the underlying conditions of bad loans: like procurement and distribution of electricity.
• Level regulatory field: Public sector employees can be brought at par with their private sector counterparts, improving risk appetite for lending, and permission to offer market salaries.
• Easing department of financial services’ chokehold: It might see PSBs step up in both lending and capital raising.