The Reserve Bank of India (RBI) continued its bar on the entry of large businesses into banking, going against the recommendation of its Internal Working Group (IWG). The central bank thus continued the policy as espoused by former RBI governor Raghuram Rajan and deputy governor Viral Acharya, who had sharply opposed the entry of big business in the banking sector.

Why RBI opposes entry of big corporates into banking?

Despite the recommendation of its IWG, the RBI put on hold the idea of granting banking licences to big corporate houses. The central bank’s main opposition remains the possibility of connected lending and self-dealing from businesses.

Business houses are able to obfuscate their connected party or related party lending through layers of corporate layers consisting of complex company structures and subsidiaries and lending to suppliers and promoters of the company. Due to the highly-complicated business structures of these companies, self-lending is also hard to detect by regulators.

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What is connected lending?

Connected lending refers to a banking entity’s owners or promoters lending to themselves or their related parties and group companies. These loans are often given with extremely favourable terms and conditions and are used by companies to get financing without any of the due diligence and oversight done by third party banks.

Since big businesses are some of the biggest classes of non-performing assets (NPAs) in banks ledger books, the presence of easily available lending to banks can further increase the amount of NPAs in the economy.

The company will use the banks as a “private pool of readily available funds,” former RBI governor D. Subbarao had once stated in reference to the RBI’s stance on entry of big businesses in banking.

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“The history of such 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,” Rajan and Acharya had added in a joint note.

Will big businesses never be allowed in banking?

India lacks the regulatory and supervisory framework and expertise to monitor cases of connected lending or self-lending done by big businesses. But as the country develops more robust regulations and frameworks for private sector banks, the possibility of businesses entering the banking sector remains a possibility in the future.

Also read: RBI working group recommends new law for digital lending

The central bank already accepted 21 out of the 33 recommendations set out by the IWG for changes in rules for ownership and corporate structure for Indian private sector banks. This includes the recommendation to raise the cap on bank promoters' stakes in the long run of 15 years to 26 percent from 15 percent.

(Edited by : Shoma Bhattacharjee)

First Published:Nov 29, 2021 8:04 PM IST