The IWG report comes not a day late. The report goes a long way in addressing lacunae built up over the years and will advance India’s journey to a $5 trillion economy by reigniting the banking sector. RBI should move quickly to act on these recommendations.(REUTERS)
The IWG report comes not a day late. The report goes a long way in addressing lacunae built up over the years and will advance India’s journey to a $5 trillion economy by reigniting the banking sector. RBI should move quickly to act on these recommendations.(REUTERS)

A breakthrough in banking reforms

RBI must implement its internal report allowing industrial houses to own banks, with checks
UPDATED ON NOV 25, 2020 07:57 PM IST

The Internal Working Group (IWG) constituted by Reserve Bank of India (RBI) to review ownership guidelines and governance structures in respect to private sector banks has submitted its report. The report is grounded, logical, clear, consistent, and does not fudge or pass up on issues that require coordination outside of RBI’s ambit. It has the courage to explore and challenge continuing holy cows and demonstrate one attribute in its recommendations, what former Securities and Exchange Board of India chairman M Damodaran once called, the least common of the senses, common sense, in abundance.

Let’s evaluate what it has suggested and its logic.

One, IWG has suggested that RBI regulations need to be consistent and the same for all players, irrespective of their licensing date. They have suggested that there is need for harmonisation of various licensing guidelines, relaxations made at any point of time are available to all players, and any tightening in rules also apply to all players in a non-disruptive manner. It has further gone on to aver that the holding by a promoter should have a clear and consistent definition, which does not get changed by separate RBI circulars. It has suggested the use of “paid up voting equity share capital” (equity henceforth) as the right metric. All these recommendations should be obvious and be a basic tenet of providing a level-playing field in the banking sector.

Two, IWG has also made some substantive recommendations on licensing policy. They suggest that promoters of banks be allowed to hold 26% equity stake in steady state or after 15 years. This is against the existing norm of 15%. Promoter holding at the start of the bank should be a minimum of 40% of the equity for the first five years. Our experience with old private sector banks illustrates that boards, where equity ownership is diversified, can take control of a bank and start to direct its operations in a less than optimal manner — Catholic Syrian Bank and Lakshmi Vilas Bank are good examples of this. In fact, 12 old private banks are laggards in respect to technology and risk systems and have not grown their share from 4% of the assets of the system.

Interestingly, our current norms permit foreign ownership, mostly by foreign institutional investors (FII), up to 74% and believe these FIIs are better owners than a promoter, who has invested capital to start and build a bank. Thus, allowing promoters with more skin in the game 26% holding seems to be a smart move. Similarly, the recommendation on a higher minimum initial capital of 1,000 crore makes eminent sense as it ensures only serious entities enter the space.

Three, after a careful international review, IWG has recommended a sympathetic review of whether industrial houses should be allowed to own banks if they meet the fit and proper criterion. It has asked RBI to address any outstanding issues or concerns in respect to connected lending and put safeguards in the Act to ensure this, so that applications from industrial houses for bank licences may be considered on the basis of a fit and proper criterion.

Four, it has forcefully recommended that RBI seriously consider Non-Bank Finance Companies (NBFCs) with assets of greater than 50,000 crore, and in operation for over 10 years, to be allowed to be converted to banks, whether or not they are owned by industrial houses. RBI has always been comfortable allowing NBFCs to be owned by industrial houses but has struggled to get comfortable in allowing them bank licences. I have never been able to understand the underlying logic of allowing industrial houses NBFC ownership but preventing them from owning banks. It presumes that industrial houses will find it easier to default on an Indian depositor over a public sector bank (from where they currently get most of their funds). To prefer NBFCs, dependent on wholesale funds and subject to asset liability mismatches, over banks with a stable liability base, has been a strange continuing preference of the regulator that IWG has challenged. In fact, I have always argued that large NBFCs should forcibly be converted into banks or be forced to acquire old private banks to mitigate systemic risk in the sector.

Five, IWG has also made a host of sensible suggestions in respect to creating a consistent regulatory regime in India. After an objective assessment of the extant regulations, it has suggested that all banks should be held by a Non-Operating Financial Holding Companies (NOFHC) but that this should not be enforced till there is a tax-neutral status to move from one structure to the other. The group has then made sensible suggestions on a set of outstanding issues in respect of pledging bank shares, issuing ADR/GDR, maximum share holdings by non-promoters, ownership norms around joint ventures and alliances. It has also recommended that banks carry out any activity that is permissible in the bank, within the bank and not in a separate subsidiary.

The IWG report comes not a day late. The report goes a long way in addressing lacunae built up over the years and will advance India’s journey to a $5 trillion economy by reigniting the banking sector. RBI should move quickly to act on these recommendations.

Janmejaya Sinha is Chairman, BCG India

The views expressed are personal

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