A Capital Mistake

The Indian Express     27th November 2020     Save    
QEP Pocket Notes

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.

QEP Pocket Notes