Allow corporate houses to own banks

By Neeti Shikha & Rahul Prakash

The banking sector in India is one of the most tightly-regulated ones considering the social implications of the negative spillovers. Despite this, bank failures have been somewhat recurring. Blame it on lax regulatory oversight or bad governance, banks have continued to gather NPAs while sparking lesser confidence among investors.

Recently, RBI has released the Report of the Internal Working Group set up to Review extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks, which recommends that promoters be allowed to increase their stake to 26% in private banks. The rationale for permitting higher shareholding, of up to 26% of the paid-up voting-equity share capital is that it will enable promoters to infuse more funds, critical for expansion of banks as a cushion to rescue the bank in times of distress/cyclical downturn.

The IWG also speaks of review of the ownership guidelines to allow large corporate/industrial houses as promoters of banks. This is in sharp contrast to the rule stipulated by RBI which mandates that a private bank’s promoters must bring down their holdings to 40% within the first three years of operation, 20% within 5 years and so forth. The dominating logic behind such a regulatory line was the reduction of governance risk and ultimately making the depositor’s money more secure.

The suggested change to this is laudable and will help increase competition among the banks, If we analyse the performance of the private sector banks in India, we would find that banks with relatively higher stakes of promoters are performing better than the diversified ones, with the exception of HDFC. Kotak Mahindra Bank and Bandhan Bank have a return-on-asset of 2.14% and 4.21%, higher than any other private bank in India. Similarly, on other parameters like net NPAs, return on equity, net interest income as a percentage of operating Income, they are performing significantly better than other private sector banks with diversified holding.

One of the unintended consequences of limiting the promoter’s stake has been an increase in foreign investors’ holding in the domestic private banks of India. More than 70% of the holding of HDFC, ICICI is with foreign investors. Effectively, they are foreign-owned banks operating in India.

There are arguments that banks led by business houses may divert funds through loans to related-party businesses because of the weak regulatory framework in India. While there is some merit in the argument, a complete ban is no answer to weak regulation. Also, if we go by this argument then government-owned banks would not have lent to bankrupt state electricity boards.

The government sees this as an important exercise in setting the stage for privatisation of banks. It is in the interest of the market that invisible hands are strengthened by promoting pro-business policies, through providing of equal opportunities for new entrants. Government has infused large amounts of taxpayer money into the ailing public sector banks. By taking advantage of the new rule, it may now tap domestic capital to effectively capitalise and privatise these banks. It would allow the government to use fiscal resources in other sectors like health and education. The big challenge, of course, will be winning the trust of the public, who will park their funds with such private banks.

Banks, unlike other businesses, are rarely allowed to fail and every time there is a probability of this, the state steps in for their rescue. The recent cases of the Lakshmi Vilas Bank and Yes Bank are testimony to this. There have been several cases of related-party transactions and bad lending in the past, the impact of which has been very harsh for the indian economy. The growing NPAs are one of the consequences of weak corporate governance in India and weak regulatory oversight.

One may question the wisdom of allowing promoters to participate in banking business but the main weakness in the banking sector is its regulation. Once that is rectified, there will be no need to ban the corporate houses from owning the banks, and India can also have its own JP Morgan!

Shikha is head, Centre for Insolvency and Bankruptcy, Indian institute of Corporate Affairs and Prakash is PhD candidate at University of Texas
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