Corporate Ownership Of Banks: Ask How, Not IfBloombergQuintOpinion
The Reserve Bank of India Internal Working Group’s report and recommendation on ownership guidelines is rich in content and perspective. The suggestions, on rationalising holding structures of banks as well as providing level playing fields for banks which came into being under an evolving licensing regime, have been lauded by one and all. However, the suggestion pertaining to allowing ownership of banks to industrial houses has created quite a storm. Both sides of the debate have strong arguments, some of which are real. As Neils Bohr, the great physicist, pointed out: The opposite of profound truth is never a lie but may as well be another profound truth. This article argues that while concerns on industrial houses may be valid, a blanket ban on ownership is not the solution. Tracking connected lending, given the current data and available technology, while not perfect, is a largely solvable issue. That leaves the issues of banking supervision and governance. If these two do not improve from current levels Indian banking would have a lot many headaches waiting for it. If there is progress on these two fronts, de jure and de facto, and we get closer to global best practices, then industrial house ownership of banks will cease to be an issue.
‘Unholy’ Cow Stuck In A Time Warp
Before the 1970s, Indian banking was owned in large parts by industrial houses. The inadequacies of banking in that period is well documented. Such were the failings that recently even believers of market economics have hinted at virtues of bank nationalization to the extent it ended bank’s ownership by industrial houses. As such bank ownership by industrial houses is a contentious issue in most countries. While few countries have an outright ‘ban’ on the ownership others allow a more calibrated and layered ownership of banks. What is important is that regulatory and legal contexts evolve. The Glass-Steagall Act was passed in 1933 in the United States in response to bank failures during the Great Depression. This Act separated investment banking from commercial banking. It was repealed in 1999 by the Gramm-Leach-Bliley Act. The debate continues well into the 21st century on whether Glass-Steagall should have been repealed. Then, in 2008, U.S. policymakers made a volte-face on the long-standing approach of keeping investment banking separate from commercial banking. In response to the global financial crisis, the US regulators and lawmakers thought it was prudent for commercial banks to own investment banks, in a bid to increase financial stability.
By the same breath, the argument that Indian industrial houses should not be allowed ownership of banks merely because that is how it has been for the last 50 years, should be reconsidered.
The Need For Capital
The Indian banking system needs growth capital in the medium term. For PSU banks, the capital requirement for growth is more immediate, in the short-to-medium term. Given the stretched government finances, and the clamour for reducing government holding of PSUs, equity capital will be required from alternate sources. Where will such a large quantity of equity come from? The foreign investment level in private banks often raises hackles about whether these otherwise Indian private banks are foreign-owned. Of course, most countries worry about the level of foreign ownership of their banking system. In the name of diversified shareholding by the Indian public, we may end up seeing PSUs owned by LIC and EPFO, as if their current ownership of Indian banks is not enough. If there are cash-risk corporates who may invest, a blanket closing down of that option may not be prudent.
Governance Failures, The Unfortunate Unifier
Under the current governance structure, every conceivable pattern of bank or financial institution ownership has presented its weakness. This is not to say that we can casually add another allegedly weak ownership structure to the existing challenge. But Global Trust Bank to Laxmi Vilas Bank and an IL&FS in between have each presented governance and operational risks which are endemic issues. IL&FS had powerful institutional ownership, with board representation. Still, the rot was not prevented. Several private banks, with diversified shareholding, seemingly had loan processes being influenced by top bosses. In each case, the board has not been able to act early enough. The regulatory audit and external audit processes associated with these institutions present glaring inadequacies. The current governance standards, and the precision and incisiveness of the audit quality, need to get closer to global best practices. If these governance improvements happen, the ownership structure will become a non-issue.
Banking Supervision: Not Just RBI’s Headache
While the onus of bank audits formally lies with RBI, it would be incorrect to put all the blame on it and absolve everyone else for the lapses over the years. Financial markets and institutional investors have, more often than not, failed to hold banks to account for their corporate governance. Even before 2014, the publicly available data was enough to project the NPA debacle but few voiced it publicly, and even fewer acted on it. Is this inactivity due to limited disclosure levels in annual reports? This brings us to the question that must be asked of SEBI.
Why are the disclosure levels of Indian banks lower than what may be required, say, in the U.S. by the Securities and Exchange Commission under the Form 10-K disclosures?
Why should the Indian investor settle for anything less?
Connected Lending: Tracking Difficult But Not Impossible
The most popular criticism against industry houses ownership of banks in connected lending. The narrative is that the money from depositors will go out as loans to business entities connected with the promoter. That can happen. Even in banks with diversified shareholding, there have been allegations that the top bosses influenced loans to be given to ‘connected’ entities. This is a lapse of governance and not unique to any type of ownership. If any regulatory entity wanted to check or control this, it could have done so at any time in the last five years by leveraging data and technology. That would have addressed a large part of the problem, albeit not all of it.
This process, per se, does not need to wait for the creation of a ‘’Public Credit Registry’. It can be done now if the authorities or regulators find it a priority.
An Eye On The Future
The binary debate we have seen so far is anachronistic and looks to the past instead of the future. Even as we discuss bank ownership in India, current global regulatory concerns range from the influence of unregulated entities such as big tech on banking; data privacy and open banking; and even the decadal favorite - the ‘normalisation’ of interest rates.
Improving the level of governance in banks and developing techno-analytical capabilities for bank supervision is critical for the future success of India's banking industry. The absence of such capabilities does not mean that they can never be developed. For argument’s sake, let’s shift the focus from connected lending to borrowing technical prowess from other group businesses. The status quo may actually keep out a class of potential bank owners that already have these capabilities. As such, what harm can it cause if an Infosys or a TCS decides to open a digital bank in India?
Deep Narayan Mukherjee is a financial services professional and a visiting faculty on risk management at Indian Institute of Management, Calcutta.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.