Here's why former RBI governor Rajan and former deputy Acharya believe the plan to allow corporations to own banks is a 'bad idea'

• Former Reserve Bank of India (RBI) governor Raghuram Rajan and former deputy governor Viral Acharya believe that the move to let large corporations own banks is a ‘bad idea.’
• Not only would this further consolidate financial power in the hands of the few, but it would essentially leave these companies open to the temptation of unlimited funding.
• Analysts at Macquarie and Edelweiss Research have also warned that allowing corporates and NBCFs to bid for banking licenses would not be a wise choice.

India’s banking sector has been lauded for its strength in the past, but that was before the IL&FS crisis and the four other banks that fell thereafter.Letting large corporations become promoters of banks would only rip down another safeguard of India’s banking sector.

According to former RBI governor Raghuram Rajan and former deputy governor Viral Acharya, going down this path is a ‘bad idea’. If industrial houses have in-house banks, the level of governance and lack of transparency will deteriorate further.

Their direct access into the financial veins of the system would only increase the concentration of economic power in the hands of the few at the top rather than be a force for equality.

The second risk that lays ahead is that the more interdependent and connected the banking system — and the powers behind it — become, the greater the probability of banks becoming ‘too big to fail’, according to Rajan.

That may be good for the customer in the short run, but in the long run it would leave India’s central bank with no option to bailout banks every time they miss a step.

Global research company Macquarie has also warned that allowing non-banking financial companies (NBFCs) and corporate houses to bid for a banking license would be very controversial in light of bank failures increasing in India.

Why having on-tap funding is a bad idea
One of the primary lessons that India has learned in the last decade is that if a corporation has access to funding without any checks in place, it tends to go the wrong way.

One example would be of Nirav Modi, once lauded as India’s top international jewelry designer but now dubbed a fugitive on the run. He’s on the hook for scamming the Punjab National Bank out of ₹11,356.84 crore by getting letters of undertaking without putting up any collateral.

“Regulars can succumb to either political pressure or the urgency of the moment,” noted Rajan.

In the Punjab and Maharashtra Cooperative (PMC) Bank scam, which is yet to be resolved, the bank’s chairman S Waryan Singh allegedly created fake accounts to hide taking out loans for the almost-bankrupt HDIL in which he held 1.91% stake.

Even in the YES Bank crisis, the bank’s founder and promoter Rana Kapoor took kickbacks to give loans without conducting due diligence.

These are just more examples of how having access to unfettered financing can be too much of a temptation for some, and there’s no test to determine the worthy from the unworthy. Not yet, anyway.

“The history of such connected lending is invariably disastrous — how can the bank make good loans when it is owned by the borrower?” remarked Rajan.

Deepening the division between the haves and the have nots
The divide between the rich and the poor is already vast in India. The top 10% of the population accounts for 77% of the total national wealth, according to Oxfam’s Billionaires Report.

Even though there is no denying that banks will require capital infusion in the future, and even if banking licenses are allotted fairly — it will still be a biased process, according to Rajan. Those large business houses that already have the initial capital to put up will be at an advantage against others.

“While rules can be black and white, fit and proper criteria and due diligence will remain a grey area, in our view,” noted Macquarie’s report.

The bigger the bank is, the more interconnected, there will be more reason for the RBI to run to its rescue in order to safeguard the interests of the bank’s depositors. “The bailout costs to the exchequer could be significantly more when it comes to bank licenses to industrial houses, which will start out big,” said Rajan.

The RBI has been down this road before with Times Bank and the Bank of Rajasthan. In both cases, corporate houses were allowed to run banks before ultimately collapsing.

This time around, Larsen & Toubro (L&T) is likely to be first in line if the recommendation is approved. It has, in the past, requested a banking license and subsequently been denied. Other expected candidates include Bajaj, the Birlas and the Tatas, according to Edelweiss Securities.

But even its optimism, Edelweiss concludes, “There will be blood.”

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