Time to review bank regulation framework
RBI’s list of controls over the banking segment is vast, it may be stifling growth of the sector
Arun Jaitley’s charisma left an impression on everyone he met. I was no exception. His wit ensured that his profound comments were never forgotten. So it was, when he in his inimitable manner once remarked that “There were only two institutions in India that do not report to Parliament but reported directly to God. The Supreme Court and RBI.” And that with RBI, he was not sure about the God part! He added, “You only write with suggestions for the government!” This piece is an ode to him.
Objectively, in the past five years, RBI has been brilliant in managing interest rates and inflation in a highly unpredictable and turbulent world. This piece, though, is on bank regulation in this century. With regulation, it is vital to uncover the underlying philosophy of regulation — do we choose to regulate with a “trust and prosecute” or “suspect and constrain” mindset?
In the “trust and prosecute” mindset, RBI would trust the institutions it regulates but heavily prosecute an institution that willfully violates its regulations. The “suspect and constrain” philosophy is where it mistrusts the supervised entities. It assumes they will not follow instructions. As a result, it supervises operations minutely to prevent violations. This approach adds to the cost of regulations, hampers growth and stifles innovation, in its desire to mitigate all systemic risks. Does it succeed in doing even that?
Given that RBI strictly controls the entry and exit of institutions into the deposit-taking and lending space, in a sense, it becomes responsible for their performance. In this century it has issued only four bank licences — to Kotak Bank, Yes Bank, IDFC Bank, and Bandhan Bank. IDFC struggled and had to be taken over by a non-banking finance company (NBFC) to turn it around, and Yes Bank, quite frankly, failed. It needed capital infusion and a new management team to survive.
In effect, after its careful deliberation and selection of new entrants, RBI’s success rate has only been 50%! One bank that brilliantly succeeded, Kotak Bank (price to book over 3) has had its CEO “termed” out by a recently introduced rule. Earlier, Kotak Bank’s promoter had to go to court against an RBI directive to reduce its shareholding in violation of its original permission — one of the few times RBI had to back down and adjust its directions.
A partial list of controls RBI exercises illustrates my point. One, for bank CEOs, it selects from a shortlist, approves salary, decides term of appointment, sets maximum term, and retirement age; two, it approves board directors, decides board director remuneration, and stipulates what matters are mandatorily reported to the board; three, it decides the officials that must report to the board and not the CEO.
Four, it regulates the ownership structure and the extent of maximum single ownership in banks; five, it grants a variety of licences for operating in the financial sector — universal bank licences, branch licences to foreign banks, wholly owned subsidiary licences for foreign banks, licences for NBFCs with a variant that only 21 of them are allowed to accept term deposits (for example, Tata Capital cannot accept deposits but Shriram Transport can), housing finance companies, payments banks, small finance banks, regional rural banks, and cooperative banks; six, it applies different rules to the risk treatment of the same loan — the risk weights vary in terms of the capital required for a bank, an NBFC and an HFC. The access to SARFAESI for resolution of overdue loans is also different; seven, outside of banking, it has expanded its mandate to oversee “capital investment companies” of industrial conglomerates by dubbing them systemically important NBFCs and imposing governance and listing rules on them.
Is India well served by these controls? Is there a purpose in multiple licensing regimes? Are large NBFCs safer, dependent on just wholesale liabilities?
Is it better to have a large NBFC with ₹1 lakh crore rupees as net worth (requiring ₹5 lakh crore of wholesale liabilities), rather than having it as a bank dependent on stable retail deposits? Are our banks big enough and numerous enough to meet the needs of the third largest global economy?
RBI prefers dealing with the banks it controls rather than startups it does not understand. Its regulatory stance pushes fintech companies to partner with banks as a risk mitigation strategy. So, the entire opportunity to make India the global hub of fintech development whereby it might overtake the United States, potentially out of the GIFT city, is lost. Our regulations need to create a framework that makes it easier for fintech companies to work seamlessly with bank partners and thereby, create new bank products or enhance the quality of existing bank products and services. We need to expedite the creation of regulatory infrastructure for digital identity and asset tokenisation on the blockchain, which may enable instant secured credit and transform small and medium enterprises finance.
Currently, many fintech entrepreneurs feel working with banks is like pulling teeth. Banks just say to fintech companies, welcome to the club! To top it all, RBI is currently increasing the strength of its “on-site” supervisory staff to conduct more inspections! When it has access to all the data of every bank, is it ignoring the developments in Generative Artificial Intelligence? Shouldn’t its talent strategy change and attract the required data scientists and engineers and move away from on-site inspections? It also needs to ponder over the emissions challenge of data centres while at the same time facilitating green finance. The finance minister was prescient in her budget this year asking for a comprehensive review of our financial regulations. India can’t wait.
Janmejaya Sinha is chairman India, BCG. The views expressed are personal