An internal working group set up by the Reserve Bank of India to review ownership structure of private lenders has recommended allowing industrial houses to control banks. The committee’s recommendation should be implemented.
India needs loan growth in double digits for GDP to grow above 6 percent. We are stuck in a 6-8 percent rut for some time now. Faster loan growth will need new banks, and the most viable model is corporate-owned banks. Of course, there are systemic risks of self-dealing when companies are allowed to own and run banks, but those can be addressed by appropriate guardrails in the initial licensing conditions, and strict regulation and oversight on an ongoing basis.
There is, for sure, a demand problem for bank credit as companies are unwilling to borrow and invest in heavy industry and infrastructure, given the experience of the previous decade. There is also a supply-side issue – PSU banks’ risk appetite is broken and smaller private lenders are struggling to get retail deposits. This leaves a cluster of 4-5 banks to do the heavy lifting and that is not good enough for double-digit loan growth.
Licensing new banks is the most logical solution. That’s easier said than done, however. Who will bid for these new licenses? A start-up domestic bank generally takes 10-15 years to establish its brand, build a deposit franchise and become viable – if it does not collapse under the weight of credit cycles by then. Most foreign banks are disinterested in the subsidiary model: they lose the backing of the global balance sheet for cross-border deals, among other problems.
The most viable model for a new bank is, therefore, ownership of an industrial house. Corporate houses can leverage existing brands to pull in depositors and can also exploit adjacencies with other parts of their group. This shortens the road to profitability, without having to take on excessive asset-side risk.
Converting corporate-run NBFCs would be a great place to start. These lenders have a track record and survived multiple shocks. This would achieve two objectives: a) NBFCs transition to more diverse and sustainable business models and b) regulators can breathe easier as large wholesale-funded balance sheets transition to more stable deposit-funded structures.
Of course, there are risks. Most countries, with good reason, do not allow industrial houses to own banks for the fear of self-dealing. It is, however, a necessity for India, and the risks can be mitigated by initial guardrails and strict monitoring. These banks should have a clear separation of management from ownership and should be subject to some unique governance rules. A stronger presence of independent directors on the board than regular banks is one such example. Exposure to group companies should be severely curtailed, with probably tighter caps on concentrated exposure to any single group.
Still, corporate-owned banks is not a silver bullet. Experience has taught us that the success rate of new banks in India is very low – it may be higher for private banks but will not be 100 percent. Strengthening and recapitalising PSU banks is also a necessity and regulators should keep multiple options on the table. Whichever route they take, the process would take 3-5 years to yield results.
Implications for existing banks: We do not see a risk for existing, well-run, banks. New entrants are more likely to expand the market rather than step on incumbents’ toes. Anyway, regulatory action on this front is not imminent – we do not expect corporate-owned banks to be a reality for 2-3 years at least (if at all). Strong franchises in India’s banking sector should continue to thrive. (Seshadri Sen is head of research at Alchemy Capital Management Pvt Ltd. Views are personal. A version of this article was previously published here.)