Rajan, Acharya denounce RBI’s new banking proposal, called “Bombshell”

The Reserve Bank of India’s (RBI’s) proposal to allow large corporate houses to set up banks is a “bombshell”, former RBI governor Raghuram Rajan and ex-deputy governor Viral Acharya wrote in a joint article on Monday. 


Emphasising on the need to stick to tried and tested limits on corporate involvement in banking, the duo said that the recent proposal is “best left on the shelf”. 

The article posted on Rajan’s LinkedIn profile — noted that the RBI’s internal working group (IWG) has suggested significant amendments to the Banking Regulation Act of 1949, aimed at increasing the RBI’s powers, before allowing corporates houses into banking. 

According to them, there are two primary reasons for not allowing industrial houses into banking. Firstly, they questioned how can banks make good loans when they are owned by borrowers themselves. 

“The history of such 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. Information on loan performance is rarely timely or accurate,” the article read. 

They further noted that RBI’s group exposure norms which limits the amount of exposure the banking system can have on specific industrial houses were also recently relaxed. “Moreover, as the WGI suggests, it is always difficult to discern the connections that make a borrowing entity part of an industrial house. Some favored ones are expanding merrily, financing asset purchases with yet more borrowing, imposing greater risks on the system,” it said. 

Secondly, they opined that the entry of private players into banking needs to be prohibited as 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 noted. 

Last week, a RBI panel had proposed 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 had 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 nonfinancial group entities. In addition, the group also proposed strengthening of the supervisory mechanism for large conglomerates. 

Rajan and Acharya also said that as in many parts of the world, banks in India are rarely allowed to fail –- the recent rescue of Yes Bank and of Lakshmi Vilas Bank are examples. For this reason, depositors in scheduled banks know their money is safe, which then makes it easy for banks to access a large volume of depositor funds. 
“Yet if sound regulation and supervision were only a matter of legislation, India would not have an NPA problem. It is hard not to see these proposed amendments as a subtle way for the IWG to undercut a recommendation it may have had little power over. 

“In sum, many of the technical rationalisations proposed by the IWG are worth adopting, while its main recommendation — to allow Indian corporate houses into banking — is best left on the shelf,” they stated. 

Source: Times of India



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