A task force set up by the Reserve Bank, the regulator, has suggestions on what to do with private sector bank ownership. Big industrial houses can be allowed to hold majority stakes, he says, but only after tightening regulation and supervision to deal with the problem of “connected lending” – essentially diverting funds from depositors to their other activities.
From the conditional nature of the recommendation, it does not appear that the regulator will soon reverse its policy of keeping conglomerates out of the banking sector. But the report could open the door to a backdoor. Large groups could acquire non-banking financial companies, which could be authorized to transform into banks. In India’s post-Covid desperation for capital, the financial system could shift from state-dominated to tycoon-led.
The Asian financial crisis of 1997-98 should be a cautionary tale. In Indonesia, the uncontrolled mix of financial and non-financial activities within a corporate group has driven the cost of bailing out banks to 40% of 1998 GDP. From telecommunications to transport, India’s business landscape is already beginning to look like a monopoly. An Indian takeover of JP Morgan, the American banker-businessman who used finance to control railroad prices and assemble a steel giant, would bring the country even closer to America’s golden age. from the end of the 19th century.
Crony capitalism slowly grew in India, emerging as a Frankenstein monster a decade and a half after politicians began unleashing the private sector in the early 1990s. It was then that, in the name of public partnership -private and rapid economic growth, a serious misallocation of credit has set in. In 2018, the financier IL&FS Group, which wrote the playbook on how to cynically exploit a poor country’s desire for better infrastructure, went bankrupt. The ensuing funding crisis brought down several titans who controlled large assets with slivers of equity.
The big churning since then has reduced competition and increased concentration. Today, the names of the national balance sheets available to Prime Minister Narendra Modi for any serious heavy lifting can fit on the back of a postage stamp. But its need to find new risk-taking private capital is high, especially after the carnage of the pandemic. Gross domestic product per capita in 2025 could be 12% lower than pre-virus estimates, “implying the greatest amount of scarring among the world’s major economies,” says Priyanka Kishore of Oxford Economics.
This is the backdrop to the internal RBI group’s review of bank ownership.
The report came just as the regulator celebrated the sale to DBS Group Holdings Ltd. Singapore of one such lender, the third failure of a large deposit-taking institution in 15 months. Before this forced marriage, the country had 22 universal banks (and 10 so-called small financial banks) in the private sector, with a 30% share of deposits, compared to 13% two decades ago. The low 5% share of foreign banks remained unchanged. The market share of the dominant public banks fell to 65% from 82% in 2000.
This process will only accelerate as state-run institutions drop from 12 to 4. Additional private banking capital will undoubtedly be needed. Yet should the country really turn to big business to provide it?
There are less risky options. For example, the RBI can stop insisting that bank licensees – who usually come from another part of the financial industry – must in the long term dilute their holdings to 15%. The task force wants the majority stake cap raised to 26%, but it could have gone higher.
The monetary authority is seeking a minimum 40% stake for a bank’s majority owner in the first five years. He could easily say, “Keep it there if you want for 15 years.” Enjoy a greater share of the loot from reasonable risk taking. If you misbehave, extend credit for bribes, persistent bad loans, or run a competing business on the side, we’ll limit your voting rights to 5%, replace your board of directors, and make your bank a target of mergers and acquisitions.
The argument for diversified bank ownership – and therefore 15% or 26% ownership limits – works when boards do their job. This did not happen at Axis Bank Ltd., ICICI Bank Ltd. and Yes Bank Ltd., which failed to rein in their longtime chief executives as bad debts piled up. The regulator was to seek or bless their ousting. Why pretend that the future will be different?
For overleveraged groups, banking licenses are a ticket to nirvana too big to fail. Savers trust the explicit deposit guarantee and implicitly trust the regulator. At Lakshmi Vilas Bank Ltd., where the central bank asked DBS to stage a bailout, deposits fell just 2% in the six months to September. That’s when everyone knew the lender – with a negative equity ratio – was toast.
The regulator should not take public trust for granted. The IL&FS debacle shows little institutional ability to stop wrongdoing outside of a traditional bank’s balance sheet. Rolling out the red carpet to become JP Morgan would be an abdication of the RBI’s financial stability mandate.
(Disclaimer: The opinions expressed in this column are those of the author. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)