CONVERSION OF LARGE NBFCS INTO BANKS, ENTRY OF CORPORATES
- Internal Working Group (IWG), five-member groupheaded by RBI Central Board Director Prasanna KumarMohanty, of the Reserve Bank of India(RBI) has reviewed corporate structure of private sector banks and has suggested sweeping changesand easier rulesthat could altogether alter the Indian bankingownership in its recently releasedreport.
- The group has suggested appropriate norms, related to the issue of excessive concentration of ownership and control, and having regard to international practices as well as domestic requirements.
- Comments on the report may be submitted by January 15, 2021.
- The IWG was constituted by the RBI on 12 June 2020 to examine and review the extant licensing and regulatory guidelines relating to ownership and control, corporate structure and other related issues.
- Now, it has recommended the guarded entry of corporates into the banking space, conversion of big NBFCs into banks and hike in promoters’ stake to 26 per cent from 15 per cent.
- The group also proposed a hike in minimum capital for new banks from Rs 500 crore to Rs 1,000 crore.
- RBI preferred NBFCs become banks as they could then be better regulated and subject to more regulations and to strengthen the supervisory mechanism for large conglomerates, including consolidated supervision.
- The changes come against the backdrop of putting the Indian economy on the path of fast growth which would not be possible without strong credit institutions. However, the liberal norms need be accompanied with changes that ensure stricter supervision and oversight of the banking system.
Suggestions in the report
- Allowing large corporate and industrial houses as promoters of banks(meaning they could take a significant stake in a lender) only after necessary amendments to the Banking Regulation Act, 1949.
- The strengthening of the infrastructure governing private lenders in India would be essential to prevent connected lending and exposures between banks and other financial and non-financial group entitiesand strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision.
- A cautious approach involving better legal and supervisory infrastructure would be essential.
- Industrial houses two options — either make a straightforward application for a licence, or those that already have lending operations can convert their existing businesses to a bank.
- A large corporate, industrial, business house means a group having total assets of Rs 5,000 crore or more, where the non-financial business of the group accounts for more than 40% in terms of total assets or gross income.
- Large non-banking finance companies (NBFCs), with an asset size of Rs 50,000 crore and above, including those which are owned by a corporate house, may be considered for conversion into banks subject to completion of 10 years of operations and meeting due diligence criteria and compliance with additional conditions specified in this regard.
- NBFCs have had this option since 2016, but this time around the regulator has gone beyond the usual conditions on eligible promoters and net worth.
- Depending on experience gained after say five years, with conversion of NBFCs into banks, the RBI may review the policies in this regard to either tighten or relax policy
- A final stake of 26% up from the current 15% could be a sweetener. For non-promoter shareholders, a uniform cap of 15% has been prescribed.
- Payments banks intending to convert to a small finance bank (SFB) need a track record of three years as a payments bank, lower than the current minimum of five years.
- SFBs and payments banks may be listed within six years from the date of reaching a net worth equivalent to prevalent entry capital requirement prescribed for universal banks or 10 years from the date of commencement of operations, whichever is earlier.
- The group recommends a higher minimum initial capital for licensing new banks of Rs 1,000 crore from Rs 500 crore for universal banks and of Rs 300 crore from Rs 200 crore for SFBs.
- It also feels the non-operative financial holding company (NOFHC) should continue to be the preferred structure for all new universal bank licences and mandatory only in cases where the individual promoters/promoting entities/converting entities have other group entities.
- While banks licensed before 2013 may move to an NOFHC structure at their discretion, once the NOFHC structure attains a tax-neutral status, all banks licensed before 2013 shall move to the NOFHC structure within five years from announcement of tax-neutrality.
- Till the NOFHC structure is made feasible and operational, the concerns with regard to banks undertaking different activities through subsidiaries/joint ventures/associates need to be addressed through suitable regulations, the group said. Banks currently under NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold.
Impact of these suggestions
- If the recommendations are accepted, this will mark the re-entry of India Inc into commercial banking 40 years after the last round of bank nationalisation in 1980. This is a step in the right direction as many of the biggest industrial groups had aspired for this ever since private players were allowed into banking after 1993.
- Many NBFCs have been keen to turn into banks as it would give them access to cheap CASA deposits even if meeting statutory ratios are initially expensive.
- The panel maks a case for ensuring harmonisation and uniformity in different licensing guidelines.
- Whenever new licensing guidelines are issued, if new rules are more relaxed, benefit should be given to existing banks, and if new rules are tougher, legacy banks should also conform to new tighter regulations, but a non-disruptive transition path may be provided to affected banks
- While acknowledging the risks posed by corporate ownership of banks, such entities can be an important source of capital and can bring in their experience, management expertise and strategic direction to banking.
- It is also a fact that many of such corporate/industrial houses have been successfully operating in other financial segments.
- The idea of allowing large non-bank lenders to convert to banks “sounds like a good one”. It is a welcome idea to boost economic activity, job creation enhancing liquidity. But the step could bring the banking sector back into the brazen arena of crony capitalism.
- Allowing large companies to promote a bank heightens the risks of misallocation of credit, connected lending, extensive anti-competitive practices, and exposure of the government safety net established for banking to a broad range of risks emanating from commercial sectors of the economy.
- Further, all the risks relating to intra-group transactions and exposures, which are existent even otherwise, like transaction risks, moral hazard risks, risk of contagion, risk of reputation get highly magnified in case on corporate ownership of banks.
- The recent failures on internal and external controls like in the case of Punjab National Bank (PNB) leading to an alarming fraud; the failures of bank and NBFCs where all stakeholders lost money and credibility requires very high degree of supervisory mechanism and corporate governance which has strong Information Technology (IT) and Artificial Intelligence (AI)-enabled platform.
- Each year the banking industry has seen more NPAs and frauds so there are compelling reasons to overcome this hurdle.
- Where corporate house is a promoter, strict regulations on the use of funds held with the bank and monitoring of related party transactions will be essential.