In November 2020, the Reserve Bank of India (RBI) constituted an Internal Working Group (IWG) to ‘review the extant ownership and corporate structure for Indian Private Sector Banks.’ There were a lot of recommendations made by the committee but there was one that became the center of debates and discussions. It not only attracted various budding economists to put up their point but had senior analysts like Raghuram Rajan and Viral Acharya having their say.
The recommendation had to be with allowing large corporates to be the promoters of private banks.
So before we go ahead, we need to know why the discussion had popped up. Since independence, the Indian Banking sector has seen a lot of twists and turns throughout its journey to date. It has been on its highs and lows during this journey. Although, it has seen some growth in the last three decades but had not been at its best in the last few years. Adding to this, it has struggled to meet the credit demand of the growing economy of the country.
We all can agree to the fact that the Indian Banking System needs a change and with that said maybe a big reform is on the way. There are a few who believe that Corporates as Banks might be beneficial for the sector however a majority of them have expressed their concern and believe that it will lead to connected lending.
Now, what is connected lending? Are there any benefits of it, if so why are so many analysts criticizing the recommendation?
There may not be a lot of arguments to justify the recommendation on an economic front but we know that the Indian Banking System requires huge capital to grow and succeed. The situation of the public sector banks is getting worse day by day. The mixture of corporates with the banks be it public or private will lead to an influx of money into the sector and the issue of the requirement of a large amount of capital in the banks might be resolved.
Banking is a service that should be available plus accessible to all. Sadly, that is not the case in India. There is a large group of people living in rural areas who do not have access to the banking sector. Experts believe that the corporates can lead the banking sector to reach the farthest point in the country. This will not only help in the growth of the infrastructure but even prosper the lives of rural people.
Lastly, the inclusion of corporates will lead to competition and healthy competition can even act as a revival for many public sector banks.
However, talking about the disadvantages of the recommendation we can find a lot of them, connected lending being the most concerning one. Shekhar Gupta, Founder of The Print in his show, Cut The Clutter defines connected lending as, “Either a private company can get its bank to lend money to itself or banks can lend to each other based on the special connection that private companies might share.”
So the banks owned by corporates might look to favour their parent companies and lend them a large sum of money. This will also lead to the transfer of business risks of the company to the banks which will put the depositors and other shareholders of the banks at a huge risk. The basic function of banks i.e. to provide efficient allocation of funds to the public which is even safe and secure will be jeopardized.
Another problem with corporates owning banks is that it will lead to the concentration of money in a few hands. The industry groups that already dominate a major sector of the economy will get more money and the gap between the rich and poor will just keep on increasing. This can even lead to corruption in politics and the dream of equality will look like a distant one then.
Due to the crisis in the banking sector in recent years, in 2016, RBI had set new guidelines on the limit of lending to a single company. The guideline is defineddefied by the recommendation of the IWG.
I believe that the government should look to strengthen the regulatory system and policies that are not strong enough in our country right now. The Reserve Bank of India needs to be a little more powerful and strict. Coming over to the Corporates in Banks, at present, the potential disadvantages have a very big edge over the potential advantages. It not only creates a lot of pressure on the banking sector but even puts the public at risk. The policy might be a good one in times to come but not the one to be implemented for the next few years.