The Story Behind New Banking Licences

Safeuarding Prudential Banking

As the Reserve Bank gets ready to announce guidelines for new banking licences within the next fortnight, the fine print in those very guidelines have become a bone of contention between the country’s central banker, charged with safeguarding prudential banking norms, and the Finance Ministry, which wants new banks to pep up the economy.

The Reserve Bank is adamant that it wants guidelines framed to keep out large corporate houses and real estate Moghuls from cornering these licences, as their business interests may clash with prudential norms needed to run banks they want to float. The finance ministry is just as adamant that rules should not keep corporate houses out, but rather rules should set up Chinese walls between owners and banking operations, so that owners can turn in profits but not subvert banking norms.

Unfortunately for North Block, the chairman of the prime minister’s economic advisory council, C.Rangarajan, a former RBI chief himself, has thrown his weight behind the central bank’s point of view.

A string of disastrous bank collapses in the 1960s, had seen the Indira Gandhi led Congress government nationalizing most large banks. There were accusations of widespread abuse of public funds by bank owners who often siphoned off monies to run risky businesses, whose failure jeopardised the entire banking and financial industry. The central banker points to this history and lack of any evidence that Indian business houses will be willing to change their ways for its unwillingness to grant bank licences to corporates.

RBI’s allergy towards real estate Moghuls like DLF being allowed to run banks stems from similar considerations, buttressed by examples of the mortgage crisis faced by American banks. The fear obviously is that realty firms allowed to own banks would use them to fund development and sale of risky realty projects, which in turn could promote a property bubble.

Finance Ministry officials argue that powers of supervision which the RBI was seeking including powers to supercede entire bank boards, if they were suspects in wholesale frauds, have been given through a banking amendment act passed by Parliament in the last Parliament session and the central bank has consequently no excuses in not agreeing to allow corporates entry into the banking sector.

One way out of the imbroglio, which is being suggested by officials trying to work out a mediation, is that the rules do not specifically prohibit large corporates from applying for licences, but preferences are built into the guidelines which would continue the current system where private banks are allowed as `graduates’ from among merchant bankers and financial firms which had grown large enough to qualify as banks.

The problem with continuation of the earlier system is that those whom the RBI granted licences last time round they were given out, included some merchant bankers who proved to be damp squibs at best and horror stories at worst – these included -- Centurion Bank and Bank of Punjab – which had to be merged and later acquired by HDFC Bank as well as scam-hit Global Trust Bank which had to be ultimately taken over by Oriental Bank of Commerce.