Context: A recent recommendation by the Reserve Bank of India (RBI), allowing large corporate or industrial houses to be promoters of private banks has raised a lot of concern.
More on the news:
- The Internal Working Group(IWG) of RBI, constituted to “review extant ownership guidelines and corporate structure for Indian private sector banks” has submitted its report recently.
- In a joint write-up, former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya severely criticised the suggestion by the IWG.
- Critical for economic growth: The banking system in any country is of critical importance for sustaining economic growth.
- Large concentration of resources in the hands of a few business families: India’s banking system has changed a lot since Independence when banks were owned by the private sector.
- Nationalisation of banks: The government resorted to the nationalisation of banks in 1969 (14 banks) and again in 1980 (6 banks).
- It was done to achieve a wider spread of bank credit, prevent its misuse, direct a larger volume of credit flow to priority sectors and to make it an effective instrument of economic development.
- Economic liberalisation in the early 1990s: The economy’s credit needs grew and private banks re-entered the picture.
Need for constituting IWG:
- Poor coverage: However, even after three decades of rapid growth, the total balance sheet of banks in India still constitutes less than 70 percent of the GDP (much less compared to China (175%)).
- Inadequate credit to private players: The domestic bank credit to the private sector is just 50% of GDP when in economies such as China, Japan, the US and Korea it is upwards of 150 percent.
- In other words, India’s banking system has been struggling to meet the credit demands of a growing economy.
- There is only one Indian bank in the top 100 banks globally by size. Further, Indian banks are also one of the least cost-efficient.
Significance of recommendation:
- Private sector will provide credit to grow: As government-owned banks, far from being able to extend credit, are struggling to contain their non-performing assets.
- Deep pockets of large corporates: With the financial resources to fund India’s future growth.
- Private sector banks are more efficient: Private banks are not only more efficient and profitable but also have more risk appetite.
- Boost private sector banking and make it safer: By bolstering prudential norms so that the interests of the depositors are secure and banks and their promoters are not able to game the system.
- Covid crisis: With growth faltering, revenues have plummeted amid Covid-19 pandemic, the government has limited ability to push for growth through the public sector banks.
Reasons for criticism:
- Compromise stability of Banking system: A predominantly government-owned banking system tends to be more financially stable because of the trust in government as an institution.
- Compromise diversity: With single owners controlling too much stake.
- Conflict of interest:
- Businesses opening their own banks will lead to “connected lending” - a situation where the promoter of a bank is also a borrower and it is possible for a promoter to channel the depositors’ money into their own ventures.
- Threat to citizen’s deposits: By mixing the class of borrowers (big companies) with the class of lenders (banks).
Though choosing the recommendation is not without serious risk of replacing the poor governance of the public sector banks with a highly conflicted structure of industrial houses ownership, ideal ownership status of banks should promote a balance between efficiency, equity and financial stability.
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