Big Businesses In Banking ? NO! : RBI

Today, we can understand why companies like Tata and Reliance won't be able to float banks in the near future.

The Synopsis

We wrote a few days ago on how central banks must be allowed to operate freely. We wrote — in it.

"Central banks serve as diligent guards in healthy democracies. Guardians with extensive economic knowledge and wisdom who can help a nation through turbulent seas. They've been taught to be patient and think about what's going on in real time. They are open and typically encourage constructive discussion and disagreement. And there's the issue of public responsibility. To avert an economic disaster, all of these characteristics are required."

And nothing better illustrates this idea than what occurred this week.

After almost a year of study and debate, the RBI (our own attentive watchdog) decided against providing full-fledged banking licences to deeply established corporate companies or industrial houses (think Reliance or Tatas).

For the uninitiated, the regulator's Internal Working Group published many suggestions on boosting the health of the private banking environment precisely a year ago. A plan to enable huge corporate/industrial entities to float their own banks was one notion that drew everyone's attention.

Many individuals at the time believed that this approach had some clear advantages. In India, the banking industry is still heavily underserved, and huge corporations have the capacity to revitalise the ecosystem. They may come in with a lot of fresh money, a lot of expertise, and a lot of brand equity to boot. And, with the present banking system stuck in a rut, saddled with bad loans, the fresh wave of licences may have been justified. More isn't necessarily better, however. As we already said in one of our posts —

Licensing is a difficult process. Consider what occurred in 1993, when the government finally agreed to allow private banks to operate in the banking industry. Four of the 10 licences awarded in the first round, in 1993–94, were sponsored by financial institutions, three by individual banking experts, one was a co-operative bank, another was an NBFC, and at the end of the line, there was an established media business. If you're curious, it was a media company. It was, after all, the Times Group.

In any case, just six of the original ten banks remain after over three decades. All three banks started by banking professionals had to combine with other private banks. Ramesh Gelli, a banking executive who promoted the Global Trust Bank, was one of the most well-known cases. After originally showing promise, the bank got caught up in the Ketan Parekh Scam after lending significant quantities of money to stock market speculators and then suffering massive losses when the markets crashed. They were eventually compelled to amalgamate with the Oriental Bank of Commerce. After merging with HDFC Bank in February 2000, the Times Group also chose to exit the banking sector.

The argument is that having more licenses does not automatically imply greater chances.

While the working group did detail how they may be able to mitigate the dangers involved with the initiative as a whole, there were harsh comments from many quarters. Former RBI governor Raghuram Rajan and deputy governor Viral Acharya were among those who spoke against the dangers of giving banking licences to corporations. Indeed, the LinkedIn article that served as the foundation for this analysis went viral in November 2020, and rightfully so.

For begin, both men were sceptical about the arrangement's nature. Their reasoning was that you couldn't expect the banking arms of these corporations to be prudent when they happen to be some of the country's largest debtors.

In the post, Raghuram Rajan wrote:

"The history of such linked lending has always been terrible - how can the bank make decent loans if the borrower owns it?" Even with all of the knowledge in the world, an independent dedicated regulator finds it impossible to be in every nook and cranny of the financial system to prohibit bad lending. Loan performance information is seldom timely or reliable."

So there were clear concerns that if any of these corporations were greedy and loaned money to associated parties, they would default on large debts, the scheme would fail. It would have been an absolute nightmare. So, after much discussion, it seems that the RBI has opted to disregard the working committee's suggestions and look for alternative methods to strengthen the financial environment in the nation.

(Source: Finshots)