Raghuram Rajan, Viral Acharya criticise idea of allowing corporates to operate banks, call it a “bombshell”

Days after a Reserve Bank of India (RBI) panel recommended corporates’ entry into banking, two former RBI governors hit out at the idea, and termed the proposal to allow corporate houses to set up banks as a “bombshell”.

Questioning the timing of the proposal, former RBI governor Raghuram Rajan and ex-Deputy governor Viral Acharya in a joint paper criticised the idea, saying that it is more important to stick to the tried and tested limits on involvement of business houses in the banking sector.

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 reads.

An Internal Working Group (IWG) set up by the RBI made various recommendations, including that a large corporate may be permitted to promote banks after necessary amendments to the Banking Regulation Act.

The IWG was set up to review extant ownership guidelines and corporate structure for Indian private sector banks.

Referring to the IWG’s proposal to allow Indian corporate houses into banking, the former governor and deputy governor said, “its most important recommendation, couched amidst a number of largely technical regulatory rationalizations, 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?” questioned the article.

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,” it said.

Rajan is currently Katherine Dusak Miller Distinguished Service Professor of Finance at The University of Chicago Booth School of Business and Acharya is a professor at the Stern School. Both of them are based in the US.