PROBLMES IN INDUSTRIES OWNED BANKS

Subject: Economy

Context: An internal working group of the RBI has recently made a recommendation to permit industrial houses to own and control banks.

Concept:

• The problem with banks owned by corporate houses is that they tend to engage in connected lending.

Over-financing of risky activities

• Lending to firms that are part of the corporate group allows them to undertake risky activities that are not easily financeable through regular channels.
• Precisely because these activities are risky, they often do not work out.
• And when that happens, it is typically taxpayers who end up footing the bill.
• In principle, connected lending can be contained by the regulatory authority.
• However, experiences in other nations show that regulating connected lending is impossible convincing most advanced countries that regulating connected lending is impossible.
• Indonesia tried to regulate the practice: It banned the practice.
• Regulation and supervision need to be strengthened considerably to deal with the current problems in the banking system before they are burdened with new regulatory tasks.

Lack of exit

• The economic landscape is littered with failed firms, kept alive on life support, making it impossible for more efficient firms to grow and replace them.
• While some progress was initially made under the Insolvency and Bankruptcy Code (IBC), this had stalled even before the pandemic, largely because existing promoters and owners mounted a stiff resistance.
• If industrial houses get direct access to financial resources, their capacity to delay or prevent exit altogether will only increase.

Increasing dominance

• The Indian economy already suffers from over-concentration.
• We not only have concentration within industries, but in some cases the dominance of a few industrial houses spans multiple sectors.
• If large industrial houses get banking licences, they will become even more powerful, not just relative to other firms in one industry, but firms in another industry.

Impact on quality of credit

• Indian financial sector reforms have aimed at improving not just the quantity, but also the quality of credit.
• The goal has been to ensure that credit flows to the most economically efficient users, since this is the key to securing rapid growth.
• If India now starts granting banking licences to powerful, politically connected industrial houses we will effectively be abandoning that long-held objective.