The much-critiqued recommendation by a panel of India’s central bank to allow large corporates to own significant stakes in banks may be tough to implement, even if accepted by the regulator and lawmakers in principle, analysts say.

An internal working group of the Reserve Bank of India recommended large corporate or industrial houses to be allowed as so-called promoters, meaning they could take major stakes in banks. Such corporate ownership will require amending the nation’s banking law to "prevent connected lending and exposures between the banks and other financial and non-financial group entities," according to the recommendations published on the central bank’s website on Nov. 20. The panel also advised stronger rules to supervise corporates that own banks.

The proposal quickly met with criticism from industry analysts and observers. Former RBI governor Raghuram Rajan said that while the working group had many suggestions for technical rationalization that are worth adopting, its main recommendation of allowing Indian corporate houses into banking "is best left on the shelf."

Rajan, in an article he co-wrote with former RBI deputy governor Viral Acharya and posted in his LinkedIn page, noted two major risks in allowing industrial houses into banking: Industrial houses could use in-house banks to obtain easy financing and allowing corporates into banking would "further exacerbate the concentration of economic (and political) power in certain business houses."

Rajan also questioned the urgency in which the working group recommended to change the existing regulations. The working group's report said that all but one of the experts it consulted were "of the opinion that large corporate [or] industrial houses should not be allowed to promote a bank" as their governance culture is not up to international standards and it would be difficult to ring-fence the non-financial activities of the corporate with that of the bank. "The corporate houses may either provide undue credit to their own businesses or may favor lending to their close business associates," according to the report.

Still, the working group said it believes that the entry of corporate players would lead to greater competition in the banking industry. It pointed out that the total balance sheet of banks in India only amounts to less than 70% of GDP, which is less, compared with global peers. Domestic credit provided by banks is still low compared with major emerging markets and developing economies, it said. With India plunging into its first recession on record, spurring banking growth to bolster the economy may be at the top of the central bank's considerations.

Fit and proper

However, analysts at Macquarie were skeptical on the implementation of the proposed changes, saying in a Nov. 20 report that industrial houses, even if they own nonbanking financial companies, may not be allowed to open a bank or convert an NBFC into a bank.

"At a time when bank failures are increasing in India, the decision to distribute licenses could be controversial ... We expect RBI to exercise caution in this regard and hence some recommendations may not come to fruition," Macquarie said. "The ultimate power of fit and proper criteria and due diligence rests with the RBI."

The RBI has a very calibrated approach in awarding new licenses, S&P Global Ratings said in a Nov. 23 report. The central bank's "fit and proper" criteria for banks give it large latitude in decision making and even a change in regulation will not mean that the central bank will be "liberally allowing corporates to start a bank."

The performance of new banks established in India over the past three decades has been "mixed," Ratings said. Of the 14 new universal bank licenses issued by the RBI since 1993, Global Trust Bank and YES Bank Ltd. had to be baled out by government-owned lenders, three lenders were eventually acquired by HDFC Bank Ltd., while ICICI Bank Ltd. and IDBI Bank Ltd. merged with their parents, it said.

"Also, and most importantly, it remains to be seen how many of these recommendations become law," it added.

India's banking sector has been hit by poor governance issues and scandals in recent years. Yes Bank, once among top-five private sector lenders in India, experienced governance issues and mounting bad loans that culminated in its rescue by the State Bank of India under a deal proposed by the central bank. The high-profile failure of Infrastructure Leasing & Financial Services Ltd. in 2018 led to a crisis in the NBFC sector. Last month, the RBI brokered a merger of troubled Lakshmi Vilas Bank Ltd. with the Indian unit of Singapore’s DBS Group Holdings Ltd.

The failures of IL&FS, DHFL and Yes Bank highlight the challenges for the RBI to prevent founders from engaging in connected lending, Hemindra Hazari, an independent analyst, wrote on his online portal HKH Research. The central bank panel's report "portends the further concentration of economic power in India, gives scope for non-transparent structures, and poses a potential threat to financial stability," Hazari wrote.