An Internal Working Group (IWG) set up by the Reserve Bank of India (RBI) has made far reaching recommendations in regard to ownership guidelines and governance structures of private sector banks. These include inter alia (i) allowing their promoters hold 26% equity stake in steady state or after 15 years (up from existing norm of 15%) from the start when it should be a minimum of 40% of the equity for the first five years; (ii) take a sympathetic review of whether industrial houses should be allowed to own banks if they meet the fit and proper criterion; (iii) allow non-bank finance companies (NBFCs) with assets of > Rs 50,000 crore, and in operation for over 10 years, to convert to banks, whether or not they are owned by industrial houses.
The above recommendations need to be read in a certain context. Already, after a prolonged tussle, the banking regulator had allowed promoters of Kotak Mahindra Bank Ltd (originally named Kotak Mahindra Finance Ltd. (KMFL), it was the first NBFC in India to convert into a bank in February 2003) – to maintain their stake at 26% despite the 15% norm. This prompted promoters of other private sector banks who had lowered their stake to 15%, now are demanding that they be allowed to increase it to 26%; for instance, the Hinduja Group – the promoter of IndusInd Bank.
By allowing promoters of all private banks to have 26% stake, the IWG has therefore taken the logical step forward. Keeping the threshold at 15% was anomalous as with this marginal stake, the promoter won’t have the desired skin in the game and hence, won’t be having the much needed seriousness and commitment. As a result, the management and governance of the bank could suffer.
A study by Boston Consulting Group (BCG) India shows that this may well be the case. The analysis of old private sector banks done by BCG illustrates that “boards, where equity ownership is diversified, can take control of a bank and start to direct its operations in a less than optimal manner — Catholic Syrian Bank and Lakshmi Vilas Bank (LVB) are good examples of this. In fact, 12 old private banks are laggards in respect to technology and risk systems and have not grown their share from 4% of the assets of the system”.
Even so, for the promoter to initially start with 40% shareholding as per existing guidelines and then bring down to 15% (after the efforts during the initial difficult phase have borne fruit and operations stabilized), relegating him to a minor player is unfair. No wonder, KMBL promoter resisted and pleaded with RBI to allow it retain higher shareholding which the latter agreed. The apex bank should implement IWG recommendation to allow 26% share to promoter.
The recommendation of the Group to allow industrial houses own banks – subject to their meeting the fit and proper criterion and after addressing any outstanding issues or concerns in respect to ‘connected lending’ and putting safeguards in the Banking Regulation Act (BRA) – needs to be read in conjunction with another recommendation made by RBI to the finance ministry early this year.
The RBI had proposed that the Union Government reduce its shareholding in six top public sector banks (PSBs) viz. the State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BOB), Canara Bank, Union Bank of India (UBI) and Bank of India (BOI) to 26% (while concurring with the idea, for now, the Centre agreed to reduce its holding to 51% in the next 12-18 months). Realizing that the market does not have the requisite appetite, RBI thought that letting corporate in could help raise the prospects.
There are several corporate with deep pocket who can buy the shares of PSBs thereby enabling successful divestment and at the same time, help the government garner resources to rein in fiscal deficit in the current difficult year (it is aiming to garner about Rs 43,000 crore). For this to happen, the regulator has to take a policy decision to allow corporate own a bank. This is precisely what the IWG has done. But, this has invited strident criticism from experts including none other than the former, RBI governor, Raghuram Rajan.
Arguing as to ‘how could a borrower also be a lender”, they have debunked the idea stating this will lead to misdirected lending mostly to entities belonging to the industrial house that owns the bank. That the management will give loans keeping in mind what the owner (read: industrial house) wants instead of being based on due diligence and assessing viability of the project. Put simply, public deposits will be used for bolstering the business of the owner. This is sheer apprehension which they are stretching a bit too far.
Misuse of public money can happen in any bank irrespective of who owns it. In PSBs, in the past, businessmen patronized by the ruling establishment managed loans on considerations other than merit and got them ever-greened. Neither the banks insisted on repayment, nor the defaulters had any fear as those who were expected to take action chose not to act. In private banks, the situation is no different as amply demonstrated by failure of Yes Bank and Lakshmi Vilas Bank (LVB) (pertinently. none is owned by a corporate house).
Merely because an industrial house gets to own 26% in a bank (as mooted by IWG), it does not automatically follow that public deposits will be misused. Misuse or otherwise, is primarily a function of the quality of management on the one hand and supervision by the regulator (read: RBI) on the other. If, any of these prerequisites is lacking then, irrespective of who owns the bank, misuse is inevitable.
The recommendation of IWG to allow NBFCs with assets of > Rs 50,000 crore, and in operation for over 10 years, to convert to banks is in sync with the RBI stance all along. The only change mooted now is that RBI intends to permit NBFCs owned by industrial houses also to convert to bank. Herein also, an argument that the bank owner (who also runs businesses) will lend money only to entities connected with it thereby leading to concentration of economic power is untenable in view of the reasons spelt out above.
Just as in case of banks, even in the NBFC segment, while companies with fairly diversified shareholding pattern such as Infrastructure Leasing and Financial Services (IL&FC) and Dewan Housing Finance Corporation Limited (DHFL) etc have gone bust, a number of others owned by industrial houses are well run.
A view on whether or not an industrial house be allowed to own a bank can’t be taken merely on a presumption that such a bank will do something horribly wrong. This won’t happen if there is strong regulatory oversight and RBI makes proactive intervention on “real time” basis to guard against mismanagement and irregularities (instead of continuing with the present practice of bolting the stable after the horses have fled)
India needs more banks with adequate capital buffer to meet the credit requirement of a US$5 trillion economy by 2024-25 (funding on such a mammoth scale can’t be done with equity capital alone which has its own limitations). In view of this, and considering that even the government wants to open up even PSBs to private sector, there is dire need to expand the landscape of potential investors. The involvement of large industrial houses in setting up new banks or for make strategic investment in PSBs has to be seen in this broad perspective.
Accordingly, the government should take a favorable view of IWG recommendations in this regard after incorporating safeguards to address issues of ‘connected lending’ by amending the BRA, For instance, all banks should be held by a Non-Operating Financial Holding Companies (NOFHC) as proposed by the Group. Its recommendation for a higher minimum initial capital of Rs 1,000 crore (up from existing Rs 500 crore) makes eminent sense. However, there is case for raising the bar even further to say, Rs 5000 crore to ensure that only very serious entities enter the space.
The Group has also batted for ‘harmonization’ of various licensing guidelines to ensure that relaxations given at any given point of time are available to all stakeholders irrespective of when the license was given to each. Its recommendations include a ‘clear’ and ‘consistent’ definition of holding by a promoter (it has recommended the use of “paid up voting equity share capital” as the right metric); maximum share holdings by non-promoters, banks not to carry out any activity permissible within the bank, through a separate subsidiary; ownership norms around joint ventures and alliances, pledging bank shares etc. The RBI should take these recommendations on board.
.