Thinkpad: Turn! Turn! Turn!

♫ To everything turn, turn, turn...There is a season turn, turn, turn...And a time to every purpose...Under heaven.. ♫

The week that was brought so much change that this song has been stuck in our mind. Diwali is over, the seasons are turning, everyone is already (hey, it’s 2020) counting down to the turn of the year.

Turning a new direction is also what the Reserve Bank of India is attempting with its proposals on bank ownership.

The report of an internal working group released this week will occupy public debate for some time till we get a final set of rules sometime early next year perhaps. Thinkpad will certainly not be the last word on this but we’ll give you a few things to think out.

The entry of corporates into banking is the headline-grabbing change proposed. This isn’t the first time such a change has been suggested. Each time it has been suggested, the idea has been scuttled. Will it be different this time?

One difference is that the proposal comes at a juncture where banking capacity is severely constrained. The government seems to have exhausted resources and patience to support large scale PSU banking. The successful private banks are successful because they haven’t gotten their hands dirty in financing crucial parts of the economy, from infrastructure to small businesses. The much-touted NBFCs have retreated hurt to a large extent.

Who then is going to finance the economy? Large corporates?

In theory, maybe. But there is a reason that large corporates have been kept away from banking not just in India but even large jurisdictions like the United States, where the Glass-Steagall Act drew the line between commerce and banking.

It has always been feared that no regulator will be able to keep tabs on the complex web through which depositor money could be compromised to meet private corporate objectives. Even the experts the internal working group interacted with were against such a move.

Will the RBI still go ahead with it? Will the government support it with the required changes to the Banking Regulation Act? And will those changes be able to tread the fine—or perhaps non-existent—line between tightening supervision, yet giving corporate houses enough incentive to enter the business.

Given how much water we need to tread before we get there, Thinkpad believes it will be some time, if ever, before we see large corporations in Indian banking.

But that doesn’t mean there won’t be greater corporate influence in banking.

First, the proposal to allow payment banks to covert to small finance banks will permit the likes of Airtel, Paytm and others to make a bid for pure-play banking. Remember small finance banks have more flexibility in taking deposits and making loans. Payment banks can only take small deposits with tight rules on where those monies are invested. That’s one reason why telecom companies were permitted to apply for payment bank licences. Now they may have more leeway to take and use deposits.

Second, the higher promoter holding cap of 26% and non-promoter cap of 15% will permit more money to flow in, even potentially from corporates. Note that along with raising the cap on non-promoter holding to 15%, any distinction on the category of investors (individual, institution, regulated institution) is proposed to be removed.

So even if we don’t see a corporate promoting a bank, could we see them take material stake in a bank?

Finally, the idea of converting large NBFCs into banks, even if they are part of a larger corporate house, will also potentially bring more corporate influence into finance.

Are all these changes good or bad? The answer to that question will be determined by how much the regulator can strengthen its supervision and enforcement functions. Coming off a series of financial sector accidents, few will be willing to give the regulator benefit of doubt and so the RBI has a perception battle to fight if it truly wants to bring about the changes suggested in the paper.

Change is always messy. No change will be messier than the one being attempted by the RBI.

Lots to think about in the weeks and months ahead. Have a good weekend.