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VIEW: A nation gets the banks it deserves – CNBCTV18

The three big recommendations of Reserve Bank of India’s (RBI) internal working group (IWG) that can change the ground rules of banking in India are:

  1. Large conglomerates be allowed to set up banks after due changes in the law to prevent connected lending.
  2. Large NBFCs – even if they belong to corporate houses – be allowed to be converted into banks. The underlined relaxation is important because NBFCs could always apply for on-tap bank licences, but since some of the NBFCs who want a licence are part of conglomerates, they couldn’t apply for the licence until now.
  3. That payment banks can convert to small finance banks after 3 years. Hitherto payment banks could convert to SFBs only if they satisfied other criteria ie they did NOT belong to conglomerates. Now that proviso appears to have been knocked off. In short, while the IWG is making some minor recommendations, the most impactful message is to allow conglomerates to enter banking ab initio, or via the NBFC route or payment bank route. This note ponders on whether the benefits of getting big business into banking is more than the costs.The first argument in favour of allowing corporates to invest in banks is that they are the ones with money. The PSU banks are unable to finance large infrastructure projects because they need capital which the government is unable to provide since the fisc is way too stretched.  The private banks have shown more appetite for retail loans and steered clear of investment in infrastructure given the risks in this business. Finally, financial inclusion hasn’t been achieved by the banks and the NBFCs which are better at last-mile lending, are lately faced with dwindling credit or high-cost credit and hence giving them bank licences will help the cause of inclusive banking.

Let us tackle these arguments one by one. Will banks backed by corporate necessarily invest in infrastructure. If Mr Uday Kotak is shying away from the inherent risks in infra funding why would another industrialist like, say Sanjiv Bajaj, think otherwise.  If Indian corporate treasuries saw a great opportunity in infrastructure financing, they would have participated by putting their money in bonds of infra companies. Indian companies could invest in electricity, water supply, telephony. But even now the last mile in electricity is being laid by governments, the last mile in telephony is provided by BSNL. Why should financial inclusion be any different?

We need to realise that financing of infrastructure is not taking off because of the political-legal-judicial hurdles. Governments are reneging on every contract: they are not paying their bills on time, not giving clearances on time and without bribes. The legal-judicial system has delayed resolution and recovery of bad loans for decades and the record of the bankruptcy code is only marginally better. Corporate India knows all this too well to risk its money again. A new bank backed by the big corporates will once again finance safe retail loans, at best.

The argument to let NBFCs become banks is more tricky. NBFCs had a whale of a time in 2017 when demonetization flooded the banking systems with deposits and helped them get money cheap. That period of euphoria ended with IL&FS and DHFL defaulting and now most of them are finding it hard to get money or are getting it at a higher cost. Should one give such hard-pressed lenders the benefit of cheap deposits of unsavvy depositors?  Also, note the argument for a banking licence itself has gotten turned on its head: NBFCs need bank licences because few lenders are trusting them and not because they are a great engine of growth.

If the benefits of giving corporates bank licences are uncertain, let us see what the costs may be. We have just come out of a ten-year cycle when corporates have shown how badly they have used depositors money. From the Essars to the Bhushans to the Kingfishers, the GVKs, the Jaypees, the Amrapalis, the Lancos, the Winsomes, the depositors’ money has been siphoned or misspent despite intermediation by neutral, professional  PSU and private bankers.

Now, would we really want corporates to directly take cash from depositors in the guise of bankers? The most recent cases of Yes Bank, LVB and DHFL are telling.  In Yes Bank’s case, the promoter took some of the riskiest bets because his personal investments needed cash; DHFL’s promoters siphoned thousands of crores from their own company and from PMC Bank by creating over 20,000 non-existent accounts. In LVB, some NBFC shareholders tried to sell their shaky loans to the bank, and when the management refused, the board members were voted out.  The cost of the many rotten apples in this segment should make us pause before we paint the sector as an engine of growth.

So does one not give licences at all to any conglomerate or NBFCs backed by conglomerates. This is the case in a bunch of countries like the US, Australia, South Korea, Philippines, Indonesia and Malaysia, besides India.

If India wants to move out of this group and allow conglomerates into banking either via NBFCs or by themselves, then it must first upgrade RBI’s supervisory capabilities significantly. With the availability of big data, SUPERTECH or supervisory technology can be built.  The central bank has begun well by building a CRILC database. It is in the process of appointing a special supervisory cadre. It already has been given charge of HFC regulation. Once the new cadre is in, supervision of HFCs must also be handed over to RBI.  Further coordination between regulators and the ministry of corporate affairs is needed to build a solid database that can detect connected persons and entities. This must be a pre-requisite even before NBFCs of conglomerates are given bank licences.

Secondly, the argument that Indian banks can’t find enough capital may be overstated. When the economy is in a growth path, capital markets are buoyant and are usually willing to give well-run banks adequate capital.  Remember India funded the rapid growth of 2003-2008 with the very same banks. Since 2008, we have added a few more banks and capital markets have gotten more robust with mutual funds and insurance companies also intermediating between savers and borrowers. So there is no need to give bank licences out of desperation. “No bankable project is ever starved of funds,” Mr K V Kamath once said.

Thirdly, the connection between the financial sector and the real economy needs to be understood. Bad banking is mostly because of a bad political economy, as we noted. Governments not paying bills, the legal system delaying decisions or interfering in commercial decisions, states not discharging elementary law and order responsibilities like preventing power theft, hazardous political promises like loan waivers. None of these will go away with a change in the bank licencing regime.

So what may be the upshot of this report?

Last time ie in 2010 after a similar discussion paper two banking licences were given – to Bandhan and IDFC. There were many applicants including those like L&T, which aren’t even owned by business families. But the Bimal Jalan committee applied the fit & proper “ rule rigorously. It may not be very different this time around. Given the recent experience with bad loans RBI, in the interest of its own credibility and the safety of depositors will be frugal with licences Secondly,  not all corporates may be wanting a bank licence. Would the Tatas bank with a Birla Bank or a Reliance Bank. The very fact that a bank is owned by one corporate may deter other corporate for banking with it.

And thirdly and most importantly the RBI report is mum about the road map of converting NBFCs to banks. If an NBFC has to maintain 20 percent SLR and 3 percent CRR from day one, it would be seriously valued destructive. Which is why even eligible NBFCs haven’t used the on-tap licence route. Will RBI give NBFCs some joining time. Going by precedent, No.

So, maybe it is going to be business as usual after all.