Netflix’s documentary ‘Bad Boy Billionaires’ related the lives and scandals of Vijay Mallya, Nirav Modi and Subrata Roy. All three businessmen had political contacts or illegal means of accessing thousands of crores of bank finance. Just imagine what would have happened if Mallya, Modi and Roy had been allowed to own banks. They would have got their self-owned banks to lend not thousands but lakhs of crores to their own dud and crooked businesses, concentrating ever more political and financial power in a few dubious hands. Ultimately those banks and businesses would have gone bust, millions of depositors would have faced the loss of their life savings, and so the government would have spent lakhs of crores of taxpayers’ money to rescue them.
Outrageous? Of course. Yet this is exactly what will be made possible by the ridiculous recommendations of a committee of the Reserve Bank of India to allow large industrial houses to own banks, reversing the policy of decades. There is an inherent conflict of interest between lenders and borrowers. Lenders want to ensure their loans are legitimate, secure and safe. Borrowers seek loans by fair means or foul. A borrower who owns a bank can play around with the savings of millions of depositors. To prevent that conflict of interest, industrialists and bankers must remain apart.
This is why many countries, including the US, prohibit large industries from owning banks. That would embed a conflict of interest in the heart of their financial system. Ostensibly, the RBI committee seeks ways to expand the banking system. The ratio of bank credit to GDP in India is barely 50% against 175% in China and nearly 200% in the US. But even at this low ratio India’s banks struggle with enormous bad debts, now exacerbated by Covid. This is not only because of crooked loans: legitimate loans also go bad if borrowers hit unforeseen hurdles, which are common in business.
India’s public sector bank culture has long reeked of political and business influence, with huge loans to favoured cronies. The situation in private sector banks is better, but still riddled with misgovernance, as shown by Yes Bank and ICICI Bank. India has several large nonbanking finance companies (NBFCs) of whom two large ones have gone spectacularly bust — IL&FS and Dewan Housing. The Indian financial system has still not recovered from the loans that went bad after the 2008 financial crisis despite enormous government rescues. Indeed, several public sector banks were placed under “prompt corrective action”, a euphemism for saying their performance was so wretched and crooked that they could not be trusted to make further industrial loans.
The answer is not to allow large industries to open banks. Large industries are not safe owners: business history is littered with big names that crashed. Vijay Mallya is an excellent example of a top businessmen with a perfectly legitimate business in Kingfisher Airlines who went bust. The RBI committee thinks that stringent rules and monitoring can ensure that a bank owned by a big sethji will not lend to his connected businesses. In practice that is impossible. Will employees of a sethji really refuse loans to the sethji’s industries or friends on technical grounds? Bad Boy Billionaires shows how massive loans are diverted to dubious characters even without their owning banks.
India has a good record of non-industrial businesses becoming banks. HDFC Bank has been called the best bank in the world. All large NBFCs can be allowed to become banks, provided they have no links with industry.
Many microfinance institutions that started small have become big, such as Bandhan Bank. Others like Ujjivan and Equitas have converted themselves to small finance banks, subject to lending limits. Some NBFCs and microfinance institutions may prefer not to become banks, but dozens will come forward if permitted. India has no shortage of non-industrial candidates with good lending records to open banks.
The RBI has licensed “payment banks”, which include telecom companies that can promote electronic payments. Payment banks are not allowed to take deposits and make loans like universal banks. The RBI committee thinks payment banks should be allowed to become universal banks, despite the clear conflict of interest.
Critics of the RBI committee include the most respected economists such as Raghuram Rajan, former RBI governor; Arvind Subramanian and Shankar Acharya, former chief economic advisors; Vijay Kelkar, former finance secretary; and Viral Acharya, former RBI deputy governor. Ignoring all of them and giving in to large industrialists would be a scandal of immense proportions. To protect his reputation for honesty, Narendra Modi should steer clear of a policy tailormade for cronyism.