Crony capitalism has also happened in public sector banks. There is a dire need to strengthen regulatory oversight to guard against irregularities in running all banks
The recommendation of an Internal Working Group (IWG) set up by the Reserve Bank of India (RBI) to allow industrial houses to own banks — if they meet the criterion — has invited strident criticism from experts, including the former RBI Governor Raghuram Rajan. Asking how a borrower could also be a lender, they have debunked the idea, stating that this would lead to misdirected lending, mostly to entities belonging to the industrial house that owns the bank. This apprehension is valid but the misuse of public money can happen in any bank, irrespective of the ownership. For instance, in Public Sector Banks (PSBs) till now, businessmen patronised by the ruling establishment managed loans on considerations other than merit. In private banks, too, the situation is no different, as amply demonstrated by the failure of Yes Bank, which is not owned by an industrial house. There is a dire need to strengthen regulatory oversight to guard against irregularities in running banks. The IWG recommends allowing promoters to hold 26 per cent equity stake in a steady state or after 15 years (up from the existing norm of 15 per cent) from the start, when it should be a minimum of 40 per cent of the equity for the first five years. It suggests taking a sympathetic review of whether industrial houses should be allowed to own banks if they meet the criterion. And considers allowing Non-Banking Financial Companies (NBFCs) with assets of over `50,000 crore, and in operation for over 10 years, to convert to banks, whether or not they are owned by industrial houses.
These suggestions need to be read in a certain context. Already, after a prolonged tussle, the banking regulator had allowed promoters of the Kotak Mahindra Bank Limited (KMBL) to maintain their stake at 26 per cent despite the 15 per cent norm (originally named Kotak Mahindra Finance Limited, it was the first NBFC in India to convert into a bank in February 2003). This prompted promoters of other private sector banks, who had lowered their stake to 15 per cent, to demand that they, too, should be allowed to increase it to 26 per cent. For instance, the Hinduja Group of IndusInd Bank made the appeal. Therefore, by allowing promoters of all private banks to have 26 per cent stake, the IWG has taken the logical step forward.
The 15 per cent threshold was anomalous, as with a marginal stake, the promoter won’t have the desired skin in the game. Hence, the much-needed seriousness and commitment would be less. As a result, the management and governance of the bank could suffer. A study by the Boston Consulting Group (BCG), India, shows that this may well be the case. An analysis of old private sector banks done by the BCG illustrates that “boards, where equity ownership is diversified, can take control of a bank and start to direct its operations in a less than optimal manner. The Catholic Syrian Bank and the Lakshmi Vilas Bank (LVB) are good examples of this. In fact, 12 old private banks are laggards in respect to technology and risk systems and have not grown their share from four per cent of the assets of the system.”
Even so, for a promoter to initially start with 40 per cent shareholding as per the existing guidelines and then bring it down to 15 per cent (after the efforts during the initial difficult phase have borne fruit and the operations have stabilised), relegating him to a minor player, is unfair. No wonder, the KMBL promoter pleaded with the RBI to allow it to retain a higher shareholding, which the latter agreed to. The apex bank should implement the IWG’s recommendation to allow 26 per cent shareholding to the promoter in the long-run.
The second major recommendation to allow industrial houses to own banks, after addressing any outstanding issues or concerns in respect to “connected lending” and incorporating safeguards in the Banking Regulation Act (BR Act), needs to be read in conjunction with another suggestion made by the RBI to the Finance Ministry early this year. The RBI had proposed that the Centre reduce its shareholding in six top PSBs, i.e the State Bank of India, the Punjab National Bank, the Bank of Baroda, Canara Bank, the Union Bank of India and the Bank of India to 26 per cent. In the follow-through, the Centre has already initiated the process to reduce its holding to 51 per cent in the next 12-18 months.
Realising that the market may not have the appetite for it, the RBI thought that letting corporates in could help raise the prospects. There are several corporates with deep pockets who can buy the shares of PSBs, thereby enabling successful divestment and at the same time, help the Government garner resources to rein in the fiscal deficit in the current difficult year (it is aiming to garner about `43,000 crore). For this to happen, the regulator has to take a policy decision to allow corporates to own a bank. This is precisely what the IWG has done. But this has invited criticism from experts who say that instead of being based on due diligence and assessing viability of the project, the bank will give loans keeping in mind what the owner wants. Put simply, this will be tantamount to the use of public money for unjust enrichment of the corporate. This undoubtedly needs a vigilant architecture. In PSBs, for instance, businessmen with political clout managed loans and got them okayed. Neither did the banks insist on repayment, nor did the defaulters have any fear, as those who were expected to take action chose not to act. This led to an increase in non-performing assets (NPAs) to an unsustainable level, forcing the Centre to bail them out by using the taxpayers’ money.
In private banks, too (albeit those not owned by a corporate house), the situation is quite similar. Merely because an industrial house gets to occupy the driver’s seat in a bank does not automatically follow that public deposits will be misused. Abuse or otherwise is primarily a function of the quality of the management on the one hand and supervision by the banking regulator on the other. If, any of these prerequisites are lacking, then, irrespective of who owns the bank, exploitation is inevitable. To handle that, there is a dire need to strengthen regulatory oversight and the RBI should make proactive intervention on “real-time” basis to prevent mismanagement and irregularities — instead of continuing with the present practice of bolting the stable after the horses have fled.
India needs more banks with adequate capital buffer to meet the credit requirement of a $5 trillion economy by 2024-25 (funding on such a mammoth scale can’t be done with equity capital alone). In view of this, and considering that the Government wants to open up even PSBs to the private sector (look at the decision to reduce its shareholding in six top PSUs to 51 per cent), there is a dire need to expand the landscape of potential investors. The involvement of large industrial houses could be of great help in this endeavour.
Accordingly, the Government should only consider the IWG’s recommendations after incorporating safeguards to address issues of “connected lending” by amending the BR Act. All banks, which have other group entities, should be held by Non-Operating Financial Holding Companies (NOFHC).
The recommendation for a higher minimum initial capital of `1,000 crore (up from the existing `500 crore) makes eminent sense. However, there is a case for raising the bar even further to say, `5,000 crore, to ensure that only very serious entities enter the space.
The third major recommendation of the IWG to allow NBFCs with assets of over `50,000 crore, and in operation for over 10 years, to convert to banks is in sync with the RBI’s stance all along. The only change mooted now is to permit NBFCs owned by industrial houses to convert to banks, too. The RBI probably went by the fact that there are a number of well-run NBFCs owned by industrial houses who can be good candidates for converting to and running a bank.
The group has also batted for “harmonisation” of various licencing guidelines to ensure that relaxations (or for that matter, tightening of rules) given at different points of time are applicable to all entities, irrespective of when the licence was given to each. Some important recommendations provide for a “clear” and “consistent” definition of holding by a promoter (use of paid-up voting equity share capital is prescribed as the right metric); maximum share holdings of 15 per cent by non-promoters uniformly for all, banks not to carry out any activity permissible within the bank, through a separate subsidiary; pledging of bank shares and so on. The RBI should build in checks and balances.
(The writer is a New Delhi-based policy analyst)
