RBI’s internal working group (IWG) recently released a report in November 2020, reviewing the extant ownership guidelines and corporate structure of Indian private sector banks. The group comprised of five members, two from RBI’s central board and three officials from RBI. The bone of contention is the recommendation that large corporate/ industrial houses may be allowed as promoters of banks. This is subject to necessary amendments to the Banking Regulation Act, 1949 and strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision. IWG also recommends that well run, large Non-Banking Financial Companies (NBFCs) with an asset size of over Rs 500 billion with over 10 years of experience, including those which are owned by a corporate house, may be considered for conversion into banks.
This recommendation by IWG is a significant departure from RBI’s stance on this topic. Currently, large corporate/ industrial houses are, similar to financial investors limited to 10 per cent holding, subject to the prior approval of the RBI. In the past, several large corporate houses in India had applied for banking license but had either backed out or were denied. RBI Governor Shaktikanta Das has clarified that the IWG acted ‘independently’ and allowing corporates to promote banks is not (yet) RBI’s view. RBI will take a view on this matter only after perusing public comments and suggestions, that may be submitted till January 15, 2021.
Several experts, including former RBI Governors, Deputy Governors and also Chief Economic Advisors fear that this could open a pandora’s box of problems. It can be noted that as per the report, all experts that it consulted except one, were of the opinion that large corporate or industrial houses should not be allowed to promote a bank.
What is the apprehension?
Interestingly the report itself highlights the relatively weak corporate governance culture in corporate houses relative to international standard and that it will be difficult to ring fence the non-financial activities of the promoters with that of the bank. Consequently, stress in non-financial activity may spill over to bank. The corporate houses may either provide undue credit to their own businesses or may favour lending to their close business associates. Not just group companies but debtors, vendors as also cross lending between banks owned by corporate houses. For e.g., 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. There are various ways of circumventing the regulations on connected lending and due to complex structures of entities, cross holding of capital, the disbursal/ diversion of funds to group concerns is difficult to monitor. Broadly, the main concerns of allowing large corporate houses to own banks relate to conflicts of interest, governance issues and concentration of economic power.
Furthermore, it is difficult to prevent influence of corporate houses on the Board in such banks, especially in the context of proposed concentrated promoter shareholding up to 100 per cent vis-à-vis the principle of diversified shareholding. It is a huge jump from the existing 10 per cent limit.
Banks are highly inter-connected entities; via a network of interbank loans as well as impact on depositor “trust” in the banking system. Since banks are allowed to take retail deposits, unlike most of the NBFCs, retail depositor’s hard-earned money is at stake. The banking system of any country is built on an edifice of trust that depositors have in their banks. The confidence that money is safe, keeps depositors away from withdrawing their funds unless they really need it. Given that banks operate on mismatched asset liability duration in near term, any panic reaction by depositors, could lead to a run on the bank and can be highly destabilizing for the banking system at large due to the inter-connectedness. That is why RBI does not let a bank fail and may use tax payers’ money to bail out failed banks.
Fit and proper
One of the major concerns that arise in context of corporate governance in banks is the type of people who control the bank. The degree of onus on the bank promoters and management should be several notches higher than other commercial enterprises. Caeser’s wife must be above suspicion. As the major shareholders/ promoters, act as trustees, it is necessary that they must be ‘fit and proper’ for the deployment of funds entrusted to them. Assessing ‘fit and proper’ status of the promoters and its large number of group entities is very difficult to articulate and very difficult to put objectively. It is not a given that the regulator will be able to withstand the political pressure at all times.
What is the problem that we are seeking to solve? Is getting credit a problem in India?
India’s ease of doing business ranking on the criterion of getting credit is a respectable 25 out of 190 nations. Fueled by the Pradhan Mantri Jan Dhan Yojana, over 80 per cent Indians have bank account. The initiatives taken by the RBI and the Government of India in order to promote financial inclusion have considerably improved the access to the formal financial institutions.
Lending in India can be broadly classified into three categories- corporate, retail and MSME. Corporate lending is fairly well covered by the Indian Banks. If lending and coverage to retail and MSME is an issue, that is largely due to the presence of a large informal sector, that banks are not able to assess (underwrite) or lend and collect (high operating cost). It is unclear how giving banking license to industrial houses will increase the lending appetite.
What is needed to plug the funding gap of retail and MSMEs is to address the information asymmetry that impedes the access to credit for micro and small enterprises. We need to focus on infrastructure development i.e. account aggregators. India needs a robust Public Credit Registry (PCR); a repository of all credit related information that would give a fillip to lending to MSMEs. Higher digitization, leading to higher formalization, higher financialization (higher savings) and democratization of data and lending would lead to easier, faster and higher lending to MSMEs.
NBFCs are comparatively less complex than banks. NBFCs have limited loan products mostly term loans and do not offer revolving working capital or non-fund facilities and therefore camouflaging is comparatively difficult. If this recommendation goes through, most of the new Banks will be existing NBFCs that will transition into Banks, who will for the medium term stay with their known lending area as they focus on liabilities and regulatory compliance. All major corporates/ industrial houses have an NBFC and will convert the NBFC into a Bank instead of a fresh Banking license. NBFC transitioning to bank will actually impact their ability as they start focus on building liability franchise, branch network, priority sector lending and other regulatory compliance.
Are Banks capital starved?
Recently, even in the pandemic, India’s top private banks have raised substantial capital to prepare for any surge in bad loans that may follow the Covid-19 crisis. Over the last few months, most major private banks (for e.g. ICICI Bank Qualified Institutional placement- QIP Rs 150 billion, Axis Bank QIP Rs 100 billion, Kotak Bank QIP Rs 74.42 billion) have raised capital following stress tests conducted internally and those mandated by the RBI. As a result, the tier-1 capital ratio and the common equity tier-1 ratio have risen to near 15-year highs, suggesting these lenders are better prepared to deal with upcoming stress. PSU Banks are struggling to raise capital– but for a reason and they would need government support.
Supervision
The other major concern posed by the mixing of banking and commerce include overburdening the supervisory resources. It will no doubt be necessary to significantly scale up the supervision capacity before considering large corporate houses to promote banks. Tracking of money trail is basically an investigative function and not a supervisory function. We need to keep in mind that RBI is a regulatory body (a watchdog); it is not an investigative agency (a hound dog). It would be unfair to expect RBI to play detective and monitor banks aggressively.
Any further banks going down would hamper public confidence
The banking sector already suffers from such challenges as financial distress and corporate governance due to doubtful credibility of third parties such as auditing firms and credit rating agencies, oversight by banks and inadequate diligence. It is extremely difficult to track complex money trail. India has witnessed various frauds in the banking space, that has led to banks being shut down or bailed out, which does not inspire confidence. Most frauds in recent times such Punjab National Bank (Nirav Modi), Infrastructure Leasing and Financial Services (IL&FS), ICICI Bank (Chanda Kochar), Yes Bank, Laxmi Vilas Bank have come to light after several years of deflecting RBI- this when there was no direct corporate house involvement. Let us take a look at some of these frauds.
A handful of PNB staffers issued fake Letter of Undertakings (LoUs) in excess of Rs 138 billion, over the years, in favour of two jewellery groups led by Nirav Modi and his uncle, Mehul Choksi. They received credit from oversees banks to fund their business/ imports. The LoUs were issued for a period of one year, for which RBI guidelines lay out a total time period of 90 days from the date of shipment. This guideline was ignored by overseas branches of Indian banks. They failed to share any document/ information with PNB, which were made available to them by the firms at the time of availing credit from them.
Nirav Modi got his first fraudulent guarantee from PNB on March 10, 2011 and managed to get 1,212 more such guarantees over the next 74 months. PNB employees misused the SWIFT network to transmit messages to Allahabad Bank and Axis Bank on fund requirement. While all this was done using SWIFT passwords, the transactions were never recorded in the bank’s core system — thereby keeping the PNB management in the dark for years.
In 2019, former vice-chairman of IL&FS, Hari Sankaran, was arrested for granting loans to entities that were not creditworthy and thereby causing loss to the company and its creditors. The first forensic audit report of IL&FS found multiple instances of potentially irregular transactions involving amount over Rs 130 billion, all with the knowledge of the top executives of the group companies.
In another instance, Chanda Kochhar abused her position in ICICI Bank to dispense Rs 18.75 billion in loans to Videocon, which then allegedly invested a part of this money in companies held by Deepak Kochhar. The loans in question were allegedly sanctioned by ICICI between June 2009 and October 2011.
Yes Bank CEO Rana Kapoor was involved in illegal gratification amounting Rs 50.5 billion along with several irregularities in distributing bank loans to corporate entities, by misusing his official position, creating shell companies for laundering money, defaults, and creating tainted assets.
Laxmi Vilas Bank had to be bailed out when its gross NPAs, which were 10 per cent in 2018, increased to 15.3 per cent in 2019 and are 25.4 per cent in 2020.
Conclusion
Internationally, most banking jurisdictions require banks to be widely held to avoid concentration of control in the interest of governance and financial stability. In the United States, commercial enterprises are not allowed to own a bank due to the concept of separation of banking and commerce. As far as fulfilling need of capital is concerned, it is not difficult to attract capital from sources other than corporate houses, for well governed banks. With well- developed equity market in India, well governed banks have been successful in raising capital from public. We must act on the side of caution; a liberal policy could put a lot of political pressure on RBI to grant license to industrial houses, which may lead to dilution of standards and build-up of systemic risks progressively.
