Banking Licenses for Corporates: Is there a catch?

On 20 December 2012, the Parliament gave its nod to the long-awaited Banking Laws (Amendment) Bill, paving the way for issuance of new bank licenses by the RBI. And now, one of the most awaited developments in the banking sector is the RBI`s announcement of the guidelines for new banking licenses. While the RBI has been trying to expedite this announcement, indecision regarding grant of banking licenses to corporate houses has been stalling the process.

While the RBI is opposed to letting corporate houses enter the banking sector, the Finance Ministry believes the RBI`s apprehensions are exaggerated and wants the RBI to change its stance. Both the sides have certain valid points and at stake is the growth of the banking sector.

India is one of the most under-banked nations among the bigger economies in the world. (The loan-to-GDP ratio is a barometer for a country`s banking penetration. India`s loan-to-GDP ratio (2011) stands at 75% vis-à-vis China`s 146% and the US` 233%.) New banking licenses are a major step towards tapping the demand for banking services. Though the number of serious aspirants for a bank license this time could number more than 20, the RBI is not likely to issue more than four. (In 1993, when the RBI licensed some private banks, it received 113 applications. Only nine were approved.)

The RBI has been known for its conservative stance in dealing with issues such as inflation and the new banking licenses are no different. RBI`s primary argument against allowing corporate houses to own banking corporations is the fear of conflict of interest. Hundreds of crores of public money might find its way from the banks to the other group companies. Similarly, it is feared that if realty firms are allowed to own banks, they will use them to fund property development and sell risky projects, which in turn could promote a property bubble.

After a string of collapses, the Indira Gandhi-led Congress government had nationalized most large banks in the 1960s. There were accusations of widespread abuse of public funds by bank owners, who siphoned off money to run risky businesses. The RBI’s unwillingness to grant licenses to corporate houses stems from this and the fact that there is no way to ensure that the business houses will change their ways. Similar considerations have also influenced the RBI’s opposition to real estate firms such as DLF.

Of late, the RBI has also found support from leading figures like Nobel laureate Joseph Stiglitz, chairman of the Prime Minister’s Economic Advisory Council C Rangarajan and economist Percy Mistry. The IMF has also supported RBI`s stance in its report “India: Financial System Stability Assessment Update”.

On the other hand, several leading corporate houses like the Bajaj group, Aditya Birla Group and Reliance are keen on starting banking operations in India. One of the major arguments being put forward by the corporates and the finance ministry is that the Banking Laws (Amendment) Bill gives the RBI sufficient powers to prevent the above-mentioned diversion of public funds. Under the new bill, the RBI can supersede the board of directors of a bank for up 12 months if it feels that the board is not working in the interest of shareholders and depositors’. In such a case, RBI could run the bank by appointing an administrator during the period. Being armed with such powers, the RBI can effectively regulate and manage the functioning of banks.

Secondly, several of the interested corporates such as the Aditya Birla Group, Mahindra & Mahindra and the Bajaj Group already have full-fledged non-banking financial companies taking deposits and lending funds. These companies have sufficient experience in handling money from a large number of retail investors; they have also created credibility and trust in this regard.

Lastly, the winners in the earlier round of bank license issuances have had a mixed record. There are successes like ICICI Bank (which converted from a development financial institution), HDFC Bank and Axis Bank. But two new banks — Centurion Bank and Bank of Punjab — merged and were later acquired by HDFC Bank. Global Trust Bank was taken over by Oriental Bank of Commerce after a major scam almost wiped out its net worth. So, one can`t say for sure that keeping corporates out of banking will reduce bank failures.

Finally, the middle way being suggested is that priority be given to non-corporate entities or merchant banking institutions who will be “graduating” to retail banking after the licenses. Also, corporate houses shouldn`t be completely barred from the process. The RBI must use its new-found powers to allow greater banking access to the populace while running a tight ship, as it has in the past. There is no other way to increase banking penetration in a 1.25-billion strong country, where over 40% of the adult population doesn`t have access to banking services.

Abhinav Tripathi is a PGP1 student at IIMA, and is member of the Consult Club here. He graduated from BITS Pilani (Pilani Campus) in 2009 with a B.E.(Hons.) in Computer Science. Prior to joining the post-graduate program at IIMA, Abhinav worked at Equirus Capital, a boutique investment bank.