Permitting industrial houses to own banks

An Internal Working Group (IWG) of the RBI has recently made a far-reaching recommendation.  According to the report, the main benefit is that industry-owned banks would increase the supply of credit, which is low and growing slowly.

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Key-Points

The IWG acknowledges that it ignored the experts the group had consulted. The report states that all the experts except one “were of the opinion that large corporate/industrial houses should not be allowed to promote a bank”.

Reacting to it, two former chief economic advisors — Shankar Acharya and Arvind Subramanian — as well as a former finance secretary — Vijay Kelkar — have called this step a grievous mistake, one that would seriously set back Indian economic and political development.

The problem with banks owned by corporate houses is that they tend to engage in connected lending. This can lead to three main adverse outcomes- over-financing of risky activities; encouraging inefficiency by delaying or prolonging exit; and entrenching dominance.