Corporate-run banks: Is it a good idea?

On November 20, 2020, the Reserve Bank of India (RBI) released the recommendations of an Internal Working Group (IWG) that reviewed extant ownership guidelines and corporate structure for Indian private sector banks. One of the recommendations suggested allowing large corporate houses to run banks. While reformers were happy with this suggestion, critics cautioned against such a move.

RBI’s reasoning:

Among several recommendations made by the Internal Working Group of RBI, one stands out : “Large corporate/industrial houses may be permitted to promote banks only after necessary amendments to the Banking Regulations Act, 1949 to deal with connected lending and exposures between the banks and other financial and non-financial group entities; and strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision. RBI may examine the necessary legal provisions that may be required to deal with all concerns in this regard.”

A large corporate/industrial/business house in this context means a group having total assets of ₹5000 crore or more, where the non-financial business of the group accounts for more than 40 per cent in terms of total assets or gross income.

The IWG gave several reasons favouring the entry of large entities in banking. It noted that such entities “can be an important source of capital and can bring in their experience, management expertise, and strategic direction to banking. It is also a fact that many of such corporate/industrial houses have been successfully operating in other financial segments. The IWG also noted that internationally, there are very few jurisdictions which explicitly disallow large corporate houses, and even in these jurisdictions, it is not a settled issued.”

To be clear, the IWG said that it was important to strengthen the robustness of institutional and legal settings before allowing corporate houses to run banks. This was required to deal with intra-group transactions and exposures that may be detrimental to the banking entity.

Criticism from experts:

It is curious to note that all the experts except one who the IWG interacted with did not support large corporate houses running banks. The experts were selected from the field of accountancy and legal practitioners, MD & CEOs of certain banks and a few senior retired regulators.

“All the experts except one were of the opinion that large corporate/industrial houses should not be allowed to promote a bank. The main reason being the prevailing corporate governance culture in corporate houses is not up to the international standard and it will be difficult to ring fence the non-financial activities of the promoters with that of the bank. Stress in non-financial activity may spill over to bank. The corporate houses may either provide undue credit to their own businesses or may favour lending to their close business associates. They may influence lending by the bank, to finance the supply and distribution chains and customers of the group’s non-financial businesses, thereby creating unreported risk to the bank. There are various ways of circumventing the regulations on connected lending and due to complex structures of entities, cross holding of capital, the disbursal/diversion of funds to group concerns is difficult to check. It is difficult to prevent influence of corporate houses on the Board in such banks. Assessing ‘fit and proper’ status of the promoters and its large number of group entities is very difficult. As far as fulfilling need of capital is concerned, it is not difficult to attract capital from sources other than corporate houses, for well governed banks. With well- developed equity market in India, well governed banks have been successful in raising capital from public,” the report states.

P.S. The IWG report can be accessed here.

Former RBI Governor Raghuram Rajan and former RBI Deputy Governor Dr. Viral Acharya think that corporate houses running banks is a bad idea. Read their views here.