Stable banking – On Banking reforms

News: The RBI last week announced that it had accepted 21 of the 33 recommendations of the internal working group set up to examine the ownership guidelines and corporate structure in private sector banks.

One of the key recommendations made by the internal working group was that industrial houses be permitted to promote banks after necessary amendments to the Banking Regulation Act, 1949.

However, the RBI has decided not to open up the banking sector for industrial houses, at least for now.

What are the arguments in support of opening up the banking sector to industrial houses?

– International examples: There are very few countries that explicitly prohibit industrial houses from setting up banks.

India needs more banks to cater to the diverse needs of both businesses and consumers.

– To improve innovation: More competition in the banking sector will increase innovation and help improve the flow of credit.

– Poor performance of state-owned banks: The Indian banking sector is dominated by state-owned banks, which as a group are not in a position to cater to the needs of the Indian economy. This is due to a variety of issues, including recurrent asset quality problems.

What are the risks involved in opening up the banking sector for industrial houses?

First, the issue of connected lending, could lead to higher systemic risks,

Second, corporatisation of banks will lead to concentration of power.

Third, India has fairly limited regulatory capability to contain both the concentration of market power and risks

Hence, the experts are of the opinion that mixing industry and finance will negatively impact growth, public finances, and the future of the country itself.

What are the other recommendations that has been accepted by RBI?

Firstly, the RBI has accepted the proposal for allowing the promoter holding cap to be raised to 26% of the paid-up voting equity capital in banks. This will enable promoters to bring in more capital if required.

Secondly, the RBI has also accepted the recommendation of subjecting large non-bank financial companies (NBFCs) to tighter, bank-like regulation. This is critical as some NBFCs have gained significant size and are systemically important.

Thirdly, the minimum capital requirement for setting up banks has also been increased. The capital needed to set up a universal bank, for example, has been increased from Rs 500 crore to Rs 1,000 crore. A higher level of capital will certainly make the bank more stable.

Source: This post is based on the article “Stable banking” published in Business standard on 29th Nov 2021.

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