rbi internal working group Archives

By now, most of our readers would have thoroughly understood the recommendations of the RBI’s Internal Working Group Report. marketfeed had prepared a detailed article on it. You can read it here. One major suggestion put forth by the group was that large NBFCs could be converted into banks if they follow specific criteria. However, our former RBI Governor Raghuram Rajan has stated that allowing corporate entry into banking is a ‘very bad idea’. Global financial analysts also have similar concerns about India’s banking sector. Let us find out why.

Inputs from a LinkedIn Post

On 23rd November, the former RBI Governor Raghuram Rajan and Deputy Governor Viral Acharya posted a joint article on LinkedIn. They have questioned the Internal Working Group’s recommendation to allow industrial or corporate houses to promote banks in India. An important question mentioned in the article is “Why now? Have we learnt something which allows us to override all the prior cautions on allowing industrial houses into banking?”.

Let us look at why they are worried about this particular suggestion:

Risky Lending Activities

According to the former heads of our central bank, a corporate entity can get funds very easily from its in-house bank (the bank which they own). These funds could be diverted or used for other activities. It would become very difficult for regulators to find faults in such lending activities. In case the corporate entity fails to repay its loans, things would become highly problematic. Also, the information shared on failed loans by the Indian banking system is not accurate. The banks also seem to cover up or conceal the information from regulators.

An example of risky lending can be attributed to the case of Yes Bank. The information regarding failed loans remained to be concealed for a long time. The private bank had to be rescued by the RBI, with the help of funding from large domestic banks. Just recently, Lakshmi Vilas Bank was similarly bailed out.

They have also stated that the RBI would sometimes be under political or economic pressures. This would force them to ‘loosen their grip’ in the financial sector. Rules and regulations would become very lenient. Ultimately, a few financial companies would have the chance to expand their businesses. These entities would also raise funds through loans to support their growth. Ultimately, such transactions would impose more risk on India’s financial system.

The Concentration of Power

The article also stated that allowing large private players to set up banks would lead to the concentration of economic and political power in certain entities. “Even if the banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up.”

According to Rajan and Acharya, most of the corporate firms have political connections. These connections will help the large entities to have an incentive to obtain a banking license. This will lead to an increase in the importance of more ‘money power’ in Indian politics.

Why Bring up Such a Recommendation Now?

The economists have come with two main reasons as to why private corporations need to get full-fledged banking licenses at this point in time.

The Indian Government is looking for more private players to bid for its public sector banks. As we know, most of the public sector units in our country are being privatized, and public sector lenders would be next in line. However, the former RBI officials have stated that this move would be “foolish”. They have argued that certain public sector banks have been under poor management over the years. Things would become even more difficult if these banks come under a highly complicated structure of ownership by large corporate houses.

Rajan and Acharya have also stated that the recommendations would prove to be beneficial for a chosen few. There could be certain industrial or corporate houses that hold payments bank licenses. And, they would be looking forward to transforming it into a universal bank.

Concerns from S&P Global Ratings

S&P Global Ratings is an American credit rating agency and a division of S&P Global. It publishes financial research and analysis on stocks, bonds, and commodities. They have also said that allowing corporate ownership of Indian banks would be highly risky.

“The RBI will face challenges in supervising non-financial sector entities, and supervisory resources could be further strained at a time the health of India’s financial sector is weak,” – S&P Global Ratings in a statement made on November 23.

The credit rating agencies’ concerns are very similar to that of Raghuram Rajan’s and Viral Acharya’s. They have further stated that corporate ownership of banks raises the risk of intergroup lending and diversion of funds. As per their analysis, the performance of new banks set up in India over the past three decades has been mixed. Of the 14 new universal bank licenses issued by the RBI since 1993, Global Trust Bank and Yes Bank Ltd. had to be bailed out by government-owned banks.

S&P Global Ratings has also stated that the conversion of NBFCs into banks will be very complex and difficult. It will also incur additional costs for these financial companies.

Conclusion

As we can see, many prominent figures and agencies have come forward to express their views on corporate entry into banking. These are very valid and relevant facts that have now questioned the objective or aim of the Internal Working Group’s Report. However, do bear in mind that the report only contains suggestions. The RBI, through further discussions and deliberations, has the final say in whether the inputs are to be implemented or not.

Let us look forward to seeing if the RBI reviews the concerns from its former head, and also from financial agencies or analysts. Do keep a close watch on the NBFC and banking stocks in the days to come.

Details of the Report

The RBI had constituted an internal working group on June 12, 2020. They were assigned the task of reviewing the ownership guidelines and corporate structure for Indian private sector banks. The IWG was chaired by RBI central board director PK Mohanty. On 20 November, the group proposed a series of significant changes. Let us look at some of these:

The cap on promoters’ stake in private sector banks in the long run (over 15 years) may be increased from 15% to 26% of the paid-up voting equity share capital. This would help to strengthen the institutional framework of banks by ensuring better promoter responsibility.

On non-promoter shareholding, the panel has suggested a uniform cap of 15% of the paid-up voting equity share capital of the bank may be prescribed for all types of shareholders.

Very importantly, large corporates and industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulation Act of 1949.

The group has also proposed a hike in minimum capital for new banks from Rs 500 crore to Rs 1,000 crore. For small finance banks, the minimum initial capital requirement may be changed from Rs 200 crore to Rs 300 crore.

Payments Banks need to have a track record of 3 years of experience in order to be converted to a Small Finance Bank. Some major examples of Payments Banks are Paytm Payments Bank, Airtel Payments Bank, and Jio Payments Bank.

Small Finance Banks (SFBs) and Payments Banks may be listed within six years from the date of reaching net worth equivalent to the current entry capital requirement prescribed for universal banks. Or, they may be listed within 10 years from the date of commencement of operations.

It has been recommended that large NBFCs could be converted into banks. However, this will be done in a strict and guarded manner. A non-banking financial company (NBFC) is a financial institution that does not have a full banking license. It is also not supervised by any national or international banking regulatory agency. As per the report, NBFCs will be eligible for conversion into banks only if they meet two main criteria:

Well-run NBFCs, including those owned by large corporate houses, should complete 10 years of operations.
They must have an asset size of Rs 50,000 crore and above.

Non-Operative Financial Holding Company (NOFHC) can remain as the preferred structure for issuing universal bank licenses. However, it should be mandatory only if the promoter or promoter group owns the other group entities. The NOFHC structure was formed by the RBI in 2013. Under it, any entity or groups in the private sector, public sector, and Non-Banking Financial Companies (NBFCs) can set up a bank – in the form of a wholly-owned NOFHC.

Banks licensed before 2013 may move to a NOFHC structure at their discretion, once the structure attains a tax-neutral status. Banks currently under the NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold.

The High Growth of NBFCs

Let us take a look at how NBFCs have performed over the last decade. Between 31 March 2009 and 31 March 2019, the total assets of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6%. During the same period, the same value for India’s commercial banks grew at a rate of 10.7%. In absolute terms, the asset size of the NBFC sector (including housing finance companies), as of 31 March 2020, is Rs 51 lakh crore. Hence, the RBI has given more attention to the NBFC segment after analysing its high growth rate for the last 10 years.

Various financial analysts have stated that this move by RBI to convert NBFCs into full-fledged banks is a step in the right direction.

“The move creates scope for large retail-oriented NBFCs with sound financial backing to become banks in order to expand their businesses further by taking deposits and increasing their number of branches” – Dhananjay Sinha, Systematix Group.

Conclusion

Do bear in mind that the report only contains possible recommendations or inputs from the internal working group. The RBI can either accept or reject these inputs. It has been stated that the suggestions would bring uniformity and relaxations in the licensing guidelines of banks. It has been reported that the promotor’s of banks such as Induslnd Bank would benefit if the 26% cap increase is introduced. At the same time, this report may be favourable for large NBFCs. We could see companies such as Bajaj Finance, Mahindra & Mahindra Financial, L&T Finance, and Aditya Birla Capital being converted to full-fledged banks. Do keep a close watch on these stocks.

As we know, the banking sector is the backbone of all economies. Any changes made to this sector will cause a deep impact on the overall functioning of our country. Strong institutions which provide credit are very essential to provide support to India’s growth. There is no doubt that these recommendations can only be implemented through precise planning and execution. Let us look forward to seeing if the RBI will make these changes over the next year. Let us also look forward to seeing more well-performing NBFCs enter into India’s banking sector.