Breaking the nexus between corporates and banks was the reason behind bank nationalisation. Recent events in India of allowing corporate houses into the banking sector should be seen with caution says MOIN QAZI..————–.An Internal Working Group (IWG) of the Reserve Bank of India (RBI) has suggested that large corporates and industrial houses may be allowed to promote banks. The group feels that allowing corporates to promote banks can be an important source of capital..In a capital-starved economy like India, this makes sense. Moreover, these corporates can bring "management expertise, experience, and strategic direction to banking"..There is logic in the suggestion, but there are major drivers behind RBI not allowing corporate intrusion in the banking sector over the last five decades..V.A. Pai Panandiker, an advisor to the Finance Ministry, wrote in August 1967: "Internal procedures… vest large discretionary powers in the boards of directors who have often acted as sources of patronage in deciding, was funneled to bank directors and their companies..In a country with weak corporate governance, there is a continuing danger of such aberrations..We are already grappling with groaning Non-Performing Assets (NPAs) and we also know the state of health of most leading private banks. Permitting corporates to promote banks will only demonstrate that we have still not seriously taken the issue of NPAs which can only grow worse in the new dispensation..Why are major corporations not allowed to enter banking?.This is the rationale for not allowing industrial houses into banking:.1. Industrial houses that need financing can manage to get it easily if they have an in-house bank without the requisite checks in place. The history of such connected lending has proved to be disastrous – a bank cannot make good loans when it is owned by the borrower..An independent committed regulator will also find it difficult to stop poor lending. Moreover, regulators can succumb to either political or other pressures..“The reason why private banks were nationalised in 1969 and 1980 was because they were pandering to the interests of their directors. .2. The second reason to prohibit corporate entry into banking is that it will further entrench the concentration of economic (and political) power in particular business houses..Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital for setting up the bank. Moreover, politically connected business houses will have the greatest incentive and ability to push for licenses..Bank nationalisation key to understanding lessons from corporate-bank nexus.We must not forget that much of India's development, particularly the upliftment of the marginalized and assistance to entrepreneurial talent in the industrial sector, has been piloted by public banks..The reason why private banks were nationalised in 1969 and 1980 was because they were pandering to the interests of their directors..The democratisation of banking came with nationalisation of 14 private banks in 1969, followed by another dose of nationalisation in 1980- putting 85% of the deposit base into the hands of the government. The justification was that it was necessary to bring banking services to rural areas and to ensure credit flowed to activities intended to fight poverty..Banks as a tool to push development.Banking was touted as a powerful tool for national development. Commercial permits for new banks were not given until 1993 when only twelve were issued. Two more followed in 2003 and 2004..The objective of bank nationalisation was threefold. The first was to break the nexus between the banks and the big businesses who were disproportionately cornering bank finance for promoting their own interests. The need was to rapidly expand the banking network to the unbanked regions, especially rural areas and deliver institutional credit to the farmers, small businesses and other weaker sections of society, many of whom were trapped in usury..“India's pile of soured loans, whose value degrades like an unstable isotope, is a classic example of how powerful and politically influential tycoons undermine rules to secure credit and then default on it..The second was to ensure the balanced flow of credit to all the productive sectors, across various regions and social groups of the country..And, finally the third was to provide stability to the banking system by preventing bank failures and curbing speculative activities..Public banks have played a historically stellar role in financial inclusion and the development of the social sector. They have been the backbone of the government's socio-economic agenda and have made a transformative impact on the country's development landscape..Public banks continue to remain the primary hope for India's financial inclusion agenda and delivery of its development programs. They are the one-stop delivery platform for all financial needs of the local rural populace..Burgeoning bad loans should caution us.It's true that India needs more banking services; but it's equally true that our banks are incurring huge loan losses, which ultimately fall on the taxpayer. It will be unwise then to induct corporate houses with significant conflicts of interest into banking..This is an untested territory and RBI should certainly be wary about the consequences of accepting the recommendation of the group..“Questionably, why should ordinary people bear the burden of fat cats who are gleefully and remorselessly winnowing scarce bank capital?.India's pile of soured loans, whose value degrades like an unstable isotope, is a classic example of how powerful and politically influential tycoons undermine rules to secure credit and then default on it..The huge losses posted by banks and desperate attempts by the government to detoxify balance sheets show how difficult it is for rescue plans to deliver..When borrowers become insolvent, their loans are added to an existing mountain of debt..Questionably, why should ordinary people bear the burden of fat cats who are gleefully and remorselessly winnowing scarce bank capital?.Already, the Government chooses these banks with spruced balanced sheets to make them lend again..Ironically, instead of being chastised, industrialists are lauded as captains of industry and adorn glorified positions in industry associations..“Any haste in giving unbridled authority to corporates to promote banks will only undo India's hard-won development gains and will also amount to unlearning several important lessons we have gleaned over the decades in financial regulation..S&P Global Ratings has already expressed skepticism in the light of India's weak corporate governance amid large corporate defaults over the past few years. It underscored that RBI will face challenges in supervising non-financial sector entities and supervisory resources could be further strained at a time when the health of India's financial sector is weak..In the agency's view, the working group's concerns regarding conflict of interest, the concentration of economic power, and financial stability in allowing corporates to own banks are potential risks.."Corporate ownership of banks raises the risk of inter-group lending, diversion of funds, and reputational exposure. Also, the risk of contagion from corporate defaults to the financial sector increases significantly," S&P has said..Former Reserve Bank of India (RBI) governor Raghuram Rajan and deputy governor Viral Acharya have also sharply criticised the recommendation.."Why now? Have we learned something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking," they have argued . They added that the proposal to let industrial houses into banking will lead to "connected lending" which, according to them, is "invariably disastrous" and would further "exacerbate the concentration of economic (and political) power in certain business houses"..The internal working group (IWG) admitted that "all the experts except one were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank". The experts consulted by the IWG included Bahram Vakil (Partner, AZB & Partners), Abizer Diwanji (Partner, EY India), Sanjay Nayar (CEO, KKR India), Uday Kotak (MD & CEO, Kotak Mahindra Bank), Chandra Shekhar Ghosh (MD & CEO, Bandhan Bank), and P N Vasudevan (MD & CEO, Equitas Small Finance Bank). The IWG also consulted experts like former Deputy Governors Shyamala Gopinath, Usha Thorat, Anand Sinha and N S Vishwanathan..In an annexure to its proposal, the IWG, headed by PK Mohanty, noted the objections raised by experts, including that a business house's non-financial activity may spill over to its bank.."The corporate houses may either provide undue credit to their own businesses or may favour lending to their close business associates. They may influence lending by the bank, to finance the supply and distribution chains and customers of the group's non-financial businesses, thereby creating unreported risk to the bank," it said..Any haste in giving unbridled authority to corporates to promote banks will only undo India's hard-won development gains and will also amount to unlearning several important lessons we have gleaned over the decades in financial regulation..Corporate governance and customer protection are the founding pillars of a robust financial architecture..(Moin Qazi is a development professional and a former banker. Views are personal.)
