Allowing corporate houses to set up banks: Raghuram Rajan-Viral Acharya duo term it as 'bombshell'

New Delhi: The RBI working group's proposal to allow corporate houses to set up banks is a 'bombshell' and at this juncture, it is more important to stick to the tried and tested limits on involvement of business houses in the banking sector, according to an article jointly written by former RBI Governor Raghuram Rajan and ex-Deputy Governor Viral Acharya.

They also said that the proposal is 'best left on the shelf.' "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 said. 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. The IWG was set up to review extant ownership guidelines and corporate structure for Indian private sector banks. Referring to the group's proposal to allow Indian corporate houses into banking, the article 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?," the article said. The article -- posted on Rajan's LinkedIn profile on Monday -- 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 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.

"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.