‘Bad idea’: Raghuram Rajan on plan to allow corporate houses to set up banks

“Connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower?" said Rajan and Viral Acharya in the jointly written LinkedIn article

Raghuram Rajan, former RBI governor, said that after experiencing a -25% GDP slump, revival is bound to happen. “The question is, what are we doing to make up the lost ground?” he said.

Former Reserve Bank of India (RBI) Governor Raghuram Rajan and its ex-Deputy Governor Viral Acharya on Monday (November 23) criticised the RBI working group’s proposal to allow corporate houses to set up banks. They termed it as “a bad idea” and a “bombshell”.

In an article jointly written by Rajan and Acharya on LinedIn, says the proposal is “best left on the shelf”.

“An Internal Working Group set up by the Reserve Bank of India recently proposed allowing Indian business houses into banking. Dr. Viral Acharya, former RBI Deputy Governor and current professor at the Stern School, and I think this is a bad idea. Our article below explains why,” Rajan, who is now Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago Booth School of Business, wrote while sharing the article on his LinkedIn profile.

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“The history of… connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending,” the article titled “Do we really need Indian corporations in banking?” said.

“…its most important recommendation, couched amidst a number of largely technical regulatory rationalisations, is a bombshell: it proposes to allow Indian corporate houses into banking. While the proposal is tempered with many caveats, it raises an important question: Why now?” they questioned.

Last week, an Internal Working Group (IWG) set up by the Reserve Bank of India (RBI) made various recommendations, including that a large corporate may be permitted to promote banks only after necessary amendments to the Banking Regulations Act.

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The article noted that the IWG has suggested significant amendments to the Banking Regulation Act of 1949, aimed at increasing the RBI’s powers, before allowing corporates houses into banking.

“Yet if sound regulation and supervision were only a matter of legislation, India would not have had an NPA problem. It is hard not to see these proposed amendments as a subtle way for the IWG to undercut a recommendation it may have had little power over.”

“In sum, many of the technical rationalisations proposed by the IWG are worth adopting, while its main recommendation – to allow Indian corporate houses into banking – is best left on the shelf,” they opined.

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“Have we learnt something that allows us to override all the prior cautions on allowing industrial houses into banking? We would argue no. Indeed, to the contrary, it is even more important today to stick to the tried and tested limits on corporate involvement in banking,” the article said.

Further, Rajan and Acharya said that as in many parts of the world, banks in India are rarely allowed to fail – the recent rescue of Yes Bank and of Lakshmi Vilas Bank are examples. For this reason, depositors in scheduled banks know their money is safe, which then makes it easy for banks to access a large volume of depositor funds.

“Why again do we need industrial houses to get full-fledged bank licenses? More important, why now, at a time when we are still trying to learn the lessons from failures like ILFS and Yes Bank?” they asked.

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