Raghuram Rajan and Viral Acharya on November 23, Monday criticised the Reserve Bank of India's Internal Working Group's recommendation to permit Indian corporate houses to set up banks as part of suggested changes to the banking sector.
Raghuram Rajan, a former RBI governor, and Viral Acharya, a former RBI deputy governor, called the proposal a "bad idea".
"It will further exacerbate the concentration of economic (and political) power in certain business houses," the two economists wrote. The duo also questioned the timing of the recommendations at at time when "India is still trying to learn the lessons from failures like IL&FS & Yes Bank".
"Many technical rationalisations proposed by RBI's Internal Working Group are worth adopting, while its main recommendation, to allow Indian corporate houses into banking, is best left on the shelf," the former RBI Governor argued.
S&P Global Ratings, on Monday, November 23, also expressed concerns over allowing corporate ownership in banks.
"The history of... connected lending is invariably disastrous -- how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending," they wrote in the article on LinkedIn.
Referring to the group's suggested changes, the article mentioned, "its most important recommendation, couched amidst a number of largely technical regulatory rationalisations, is a bombshell."
"It proposes to allow Indian corporate houses into banking. While the proposal is tempered with many caveats, it raises an important question: Why now?," the article said.
"Why is there urgency to change the regulation? After all, committee are rarely set up out of the blue. Is there some dramatic change in perception that it is responding to?" the former RBI officials asked.
"Have we learnt 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," the article read.
"If sound regulation and supervision were only a matter of legislation, India would not have an NPA problem," they said.
The former RBI officials also alleged that, "India has seen number of promoters who passed fit & proper test at the time of licensing but then turned rogue."
The two economists also listed two rationales for not permitting industrial houses into banking. First, industrial houses require financing, which they can get easily, if they have an in-house bank. second reason to stop corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses.
"Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses," they said.
Interestingly, the IWG reports in its appendix that all the experts it consulted except one 'were of the opinion that large corporate/ industrial houses should not be allowed to promote a bank'. "Yet it recommends change!," they alleged.
"A second possibility is that an industrial house holding a payment bank license wants to transform into a bank," they said.
Last week, an RBI panel had suggested that large corporates may be permitted to promote banks, as well as raising the cap on promoters' stake in private sector banks to 26 per cent, from 15 per cent at present.
The RBI panel has recommended that corporates should be allowed to control banks after necessary amendments to the Banking Regulation Act, 1949 to prevent connected lending and exposures between the banks and other financial and non-financial group entities.
Only well-managed NBFCs with more than 10 years of experience and ₹50,000 crore of assets will be permitted to convert to a bank.