Allowing business houses to own banks is fraught with risk

The thought that large business houses could own and run banks is worrying, if not frightening. Given how so many of India’s industrialists haven’t exactly covered themselves with glory and don’t trouble themselves unduly about ethics or corporate governance, it is disconcerting to think they would be controlling large sums of public money.

Much of the loan losses at our banks—of at least Rs 15-20 lakh crore over the past decade, if not more—are the result of defaults by companies, and a good part of this is wilful defaults. At one point, corporate loan losses accounted for 15-16% of the assets. To be sure, not all of the defaulting companies belonged to big industrial groups, but many did. As the IBC process showed, there were groups that owed banks Rs 45,000 crore or more, and simply didn’t pay up.

Again, it is not as though smaller promoters have behaved any better; the extent of alleged fraud at a Yes Bank, a DHFL and an IL&FS is astounding. For every success like an HDFC Bank or a Kotak Mahindra Bank, the financial landscape is blotted by big failures like Centurion Bank of Punjab, Global Trust Bank, Bank of Rajasthan, Times Bank, and most recently, Lakshmi Vilas Bank. Again, most of our public sector banks would have become insolvent had it not been for the government’s rescue efforts; about a dozen of them needed to be placed under a corrective action plan and stopped from lending. However, the ability of a big corporate bank to grab a disproportionate share of the market for deposits and also misuse or mislay money is high; there would always be the temptation to lend to group companies regardless of the risk. Consequently, such players make the system more vulnerable to instability.

At the same time, one must accept that several NBFCs, belonging to big business groups or conglomerates, have done well. Bajaj Finance, Tata Capital, M&M Financial, AB Capital, L&T Financial are all run well, and though they may have had their ups and downs, they are all solvent and have not been found guilty of any malpractice. The Reserve Bank of India’s Internal Working Group (IWG) has recommended that NBFCs with assets of more than Rs 50,000 crore, and which pass the requisite due diligence exercises, should be allowed to convert themselves into banks. On the face of it, this doesn’t seem like a bad idea, since bringing them under RBI’s oversight would ensure they are more strictly monitored. After all, they have a proven track record and are already operating in the financial services space, even if not all of them access retail deposits. However, some would argue that letting them become banks is simply giving corporates a back-door entry, and that is a valid argument. It is true NBFCs have played a big role in disseminating credit and reaching out to customers who might otherwise not have had access to organised loans. But, while giving them bank licences could be risky, the regulator must find ways to allow them to scale up their operations. RBI could allow more NBFCs to tap retail deposits while putting in some regulations.

Ideally, some of these NBFCs should have been allowed to convert themselves into banks. But unfortunately, supervision is weak, and no matter how many checks and balances we put in place, the system could be gamed, particularly, since some business groups have strong political connections. While the responsibility to prevent frauds and defaults lies with the bankers, it is also true that RBI’s supervision has not been up to the mark.

If banks were facing political pressure, which very often they were, RBI should have tightened the lending and prudential norms to protect the banks. For instance, the loan limits for business houses should have been lowered a long time ago so that no consortium of banks could have lent more than a certain amount. RBI’s excuse for not lowering these was that the idea was to promote growth and lending. However, RBI’s job is to ensure that banks remain solvent and that, at all times, they present a true balance sheet. However, unfortunately, it failed; that is evident from the collapse of a Yes Bank, where it should have kept a closer watch.

It is quite unbelievable that governors before Raghuram Rajan—Bimal Jalan, YV Reddy and Subba Rao—were not able to prevent evergreening of loans and that they did not call for an asset quality review (AQR). On the contrary, they allowed regulatory forbearance for a sector like real estate and for an Air India, in the process diluting the quality of banks’ balance sheets. RBI cannot get away by saying that regulation was stringent, but could not be enforced effectively; that is unacceptable. Neither should it asked to be excused from its supervisory role. What it needs to do now, post-haste, is strengthen regulation and supervision by investing in both manpower and technology. This is critical if there are to be no more casualties.